Joseph Krist

Publisher

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The municipal bond market, just before its recent pullback has been trading at near 70 year lows in yield. Issuers of all credit stripes are coming forward and with a couple of exceptions are finding a warm welcome for their offerings. So we’re all good, right?

This is an environment where every technique available to help municipal issuers should be utilized to deal with the lack of revenues. Instead things like advance refunding capabilities remain unavailable to issuers, This, while at the same time a real federal fiscal response to the policy of essentially downloading the operational with the pandemic responsibilities of dealing with the pandemic were devolved to the states. It is as if the decision was made to outsource services while being unwilling to pay the entities providing them.

So now we move into the fall with fiscal pressures remaining effectively unabated for government. Yet now is when some of the most significant expenses will be incurred. The preparation work to adapt classroom and other spaces for in person learning is substantial, costly, and likely to be required through at least year end. The recent experiences with college campus openings have been clearly fraught and the sort of on again off again process which some schools seem to be attempting is likely to be more costly than other responses.

The nation’s largest transit system has confirmed how much trouble it is in. The current level of ridership (est. at 25%) has generated significant operating losses which are not sustainable. The agency finds itself in the midst of a hurricane the effects of which are only partially attributable to its own decisions. MTA has requested $12 billion in aid to cover its operating losses through 2021. But that funding is at risk without a substantial federal stimulus bill. Without it MTA projects fares and tolls would be raised by one percent and one dollar, respectively, above already scheduled increases in 2021 and 2023.

The situation with the MTA is simply the largest and most glaring example of the problems. Across the country, state revenues from and for transportation are getting crushed. The situation is being replicated at various scales whether it be less funding for public transit or delayed or scaled back road maintenance and/or construction. The ability of toll roads to facilitate commercial and freight usage may position them better relative to public transit issuers but the demand issue remains in either case. The result for now is diminished infrastructure and a diminished ability to achieve full economic recovery.

So to answer our question, no it’s not alright.

TECH AND GOVERNMENT

The pandemic reinforced the importance of technology as a credit factor. Technology enabled the economy to a least limp along without utter collapse thanks to the technological innovations of the last two decades. The central role of technology in facilitating electronic transactions and video capability that allowed many to continue to work were economic lifesavers. At the same time, the reliance on technology raises several troubling aspects from a societal point of view. These include issues of equal access to education, work, and even medical care. The solutions to those issues will be decided outside of the market.

For municipal bond investors, the issue of government and technology will be a continuing source of risk and cost. You can still go to local municipal governments where the screens are black and the type is either glowing white or green. Think the movie War Games. Then you understand why you can’t complete basic tasks expeditiously or cost effectively. And it’s not a partisan thing. But it is reality and that’s the sort of thing which will throttle adaptation of technology to cover the range of potential applications government provides.

The challenge of updating and replacing information and operating technology will be its cost. Many issuers are not in a position to fund significant tech infrastructure. Yet information technology and infrastructure will be key to the adoption and implementation of technology in support of transportation. One of the ongoing debates in infrastructure world is the issue of technology based transit modalities.

Many of those at the front of the movement to make individual autonomous mobility the cornerstone of 21st century transit are finding out just how much of a chasm exists between the capabilities of government systems and corporate systems. One of the issues which contributed to the huge  level of operating problems for the California was the age of some of the software the system was based on. Some of the system was still on code written for COBOL (Look it up). They’re going to need some serious upgrades to the local tech infrastructure if the future is electric AV powered by renewable energy.

Which leads us to the issue of the effect of making decisions under duress. One of the risks for policymakers going forward as the pandemic follows its course until a vaccine intervenes, is that current conditions can generate impacts which in the longer term are not viable. It has been interesting to see how different interest groups have been actively spinning current conditions in big cities. Whether it’s the end of on street parking, punitive congestion fees, or the permanent expansion of outdoor dining, proponents do not seem to have given much thought to the long term impact of those decisions.

Take dining. The extension of dining into what were formerly parking spaces in NYC stands out. The concept works well in a time of seriously diminished traffic but is there a viable economic model for operating that way? Will it be enough to replace the 10,000 restaurants estimated to have closed in NYC since March? Are current levels of business enough to support rents long term? What tradeoffs in terms of transit and traffic must be made as the level of economic activity is on a sustained path to recovery?

We take the view that the path may be longer than one would hope but, that in a couple of years people will be happy to sit in restaurants and bars, that they will go to movies in theatres, and that once again sports stadia and arenas will be full again. The economic havoc on capital finance will serve to reinforce previously existing preferences in terms of public versus private vehicles. 

We do not subscribe to the theory that it’s the end of the world as we know it and I feel fine. It is important that decisions be made soberly rather than in the heat of battle.

PRIVATIZATION ADVOCATES TRY AGAIN

Under the heading of never letting a good crisis go to waste, the pandemic is providing opportunities for advocates of privatization of existing public assets to take another shot at public opinion. Once again, we see the private sector attempt to use the pandemic and its economic impacts to advance the cause of privatization. The latest comes from the Koch-financed Reason Foundation. It released a study which purports to offer a solution to pension underfunding through the sale of toll roads.

That study concludes that Illinois could generate the largest net toll road lease proceeds but its unfunded pension liability is so large that the lease proceeds would cover just 14 percent of its pension debt. Florida and Oklahoma could pay down half of their unfunded liabilities. Unfortunately, the study rests on some questionable calculations to arrive at its conclusions.

It also ignores the politics of privatization in states like New Jersey and Florida where toll increases generate big oppositions. It also has the bad luck to cite the Chicago Skyway and Indiana Toll Road as US examples. Neither of those deals measured up to the claims of proponents. The study draws on data from a number of overseas toll road P3 transactions in recent years to estimate what each toll road system might be worth to infrastructure investors. Unfortunately, the gross valuation is what would apply globally but that ignores the realities of municipal bonds in the United States, a change of control (such as a long-term lease) requires that existing tax-exempt bonds be paid off.

PUERTO RICO ELECTRIC

The Puerto Rico Energy Bureau is the governmental overseer of the Puerto Rico Electric Authority (PREPA). While PREPA undertakes to restructure and refinance its debt, it also is seeking to rebuild the Commonwealth’s electric system after three years of hurricanes and earthquakes. After Hurricane Maria, we made the case that the rebuilding effort had created a huge opportunity to develop a much more resilient and climate friendly electric grid. With abundant sunshine and wind available year round, the opportunity to shift from a fossil fueled to a renewable generation base was at hand.

Since Maria destroyed the system, PREPA has undertaken a plan of recovery which in many ways seeks to maintain the status quo. So we were glad to see that recent reviews undertaken by the Bureau have led to the Bureau recommending an increased reliance on renewables. It effectively rejected PREPA’s plans to increase reliance on natural gas. The regulators proposed at least 3,500 megawatts of solar and more than 1,300 megawatts of battery storage by 2025. It also sought to have PREPA reconsider its plan to spend $5.9 billion on a rebuild of the heavily damaged transmission system.

The bureau’s proposal would cost PREPA an estimated $13.8 billion compared to around $14.4 billion projected under the utility’s plan. That would represent a 4% reduction in overall costs. Not huge but still meaningful. The disagreement will likely complicate the debt restructuring process. We do not see that as a reason to plunge ahead without real debate over the future of the electric system.

We were interested by comments we saw regarding concerns over reliability of a renewable versus a fossil fuel based system. Those concerns are rooted in the fact that the utility serves a truly closed system with the added complication of reliance on 100% externally generated fuel sources. It is not obvious why concerns about redundancy for a renewable based system are any different than those which existed for the original system. Because there is no access to outside sources of power, the legacy oil and gas based system had the same issues. The risk of energy shortages (such as we see in California) has always been present in Puerto Rico. We do not think that those concerns are sufficient to discourage the development of significant renewable generation resources for PR.

WHY RUNNING GOVERNMENT LIKE A BUSINESS USUALLY FAILS

The current stimulus standoff is generating different responses from different organizations as they operate their businesses. Some of them think that their experiences provide answers to the issues government face. Most of those who think that way reveal their inability to distinguish between a business and a service. While it is not a municipal credit, the Postal Service is a good example.

The current debate effectively revolves around the issue of profitability. The President does not understand the concept of public goods. The Postal Service was never designed to be a business it was designed to be a subsidized service. The current shenanigans at the USPS are based in the belief that it must be profitable in the sense that any business must be profitable. The role of the USPS in facilitating commerce and therefore the economy has economic value. That is why only the USPS has to serve every address and is the only entity required to facilitate things like animal delivery and transport.

It is also why basic infrastructure like water, sewer, and roads have largely been developed under the framework of a public good. Public goods are not supposed to “make money”. The profit they generate is reflected in the role they play in providing a necessary service base in support of economic activity. In those situations where services provide excess revenues those are usually applied to the funding of public goods. service related surpluses fund other facilities or fund items which would otherwise be funded by taxes.

No matter how you slice it, these proposed asset sales take money from public goods and divert it to private interests. Projects which do not generate distributable returns to their investors are generally not undertaken. So at least some portion of the economic return generated by formerly public goods represents a transfer of income and/or wealth from the public to the private sector.

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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We would like to say that we are optimistic about the economic and pandemic outlooks but it is difficult to do so given the data we see. The attempt to open college campuses to significant on campus activity is already proving quite problematic. Early openers were among the most adamant supporters of doing so but they have stepped back. At the K-12 level, only New York among the nation’s largest cities is holding on to the idea of a significant in person presence. Experience to date in Chicago and Arizona indicates that it will likely be the teachers making the final call.

The implications of these failed reopenings, along with reopening fueled resurgences of the virus for the economy is clear. The return to pre-pandemic normal is increasingly farther away with all the negative implications which stem from them for state and local revenues. Even the positive trend in initial unemployment claims reversed this week. As for municipal credits, they remain in the eye of the storm as governments must manage the demand for services in a greatly reduced resource environment. The need for additional support from the federal government could not be clearer.

From a policy perspective, California will unfortunately provide another test of the impact of recent political decisions which will hurt the ability of the federal government to respond to disaster. The President is funding his unemployment extension plan with the money which was earmarked for FEMA. So in that sense it is fair to ask where disaster aid funding might be coming from? Just in the last two weeks, significant storms have hurt the northeast, Iowa, and now California is on fire. So it is not a regional or partisan issue.

We remain concerned by the current credit environment which simply does not compensate investors for the risk they hold. That makes these perilous times for those considering an increase to their exposure to risk. Tread carefully.

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TRANSIT TECHNOLOGY

Fairfax, VA is about to join sixteen other U.S. cities in the testing of an autonomous passenger shuttle. The vehicle will travel a one-mile long route, between a transit station and a downtown commercial area. The test reinforces a trend across the country. Since 2016, the National Highway Traffic Safety Administration (NHTSA) has granted permission for the testing of 87 self-driving vehicles as part of 89 different projects in 20 states. The projects include 64 publicly operating low-speed shuttles in 45 cities. In Fairfax, the 12-passenger shuttle will serve two stops, cross only two intersections, and cannot go faster than 15 mph.

The cost of the test will be divided among the Commonwealth of Virginia and Fairfax County. Dominion Energy, which would benefit from increased electric vehicle use owns the shuttle.  The shuttle’s manufacturer has experienced some problems with the vehicle’s operations. This winter, the National Highway Traffic Safety Administration suspended passenger operations on all of the manufacturer’s  autonomous shuttles in the United States. A passenger fell aboard one that was part of a pilot program in Columbus, OH when the shuttle made an emergency stop.

The agency in May allowed passenger operations to resume after additional safety enhancements were made, including corrective actions to increase awareness that sudden stops can happen, more signage and audio announcements, and retrofitting the vehicles with seat belts. A “safety steward” will always be on board. Nonetheless, officials in Columbus were recently quoted as saying that the test in the Columbus project revealed some limitations of existing technology. Left-hand turns in traffic were cited as a nonstarter and a safety driver would always need to be stationed behind the wheel.

One of the issues which has clouded the debate over autonomous vehicles is the perceived difficulty that AVs have outside of urban and suburban areas. Most of what we have seen concerns the benefits of AVs for primarily urban situations, for congestion relief or pollution reduction. What we have not seen much of is the issue of how LIDAR based systems handle the realities of rural driving. If you have ever gotten a speeding ticket based on LIDAR technology, you know how many things can impact the accuracy of that equipment.

Those systems will now be put to the test in rural settings. University of Iowa researchers with the National Advanced Driving Simulator (NADS) are preparing for an upcoming demonstration study about automated driving on rural roads. A $7 million US Department of Education grant will fund the study. As the director of the UI program put it, “There is a big difference between driving in Iowa than in Silicon Valley or states where there are 12 months of sun.”

This study, scheduled to begin in 2021, will use a custom vehicle equipped with scanning lasers known as LIDAR, computer vision systems, RADARs, and high definition maps. It will follow a 47-mile route through parts of Iowa City, Hills, Riverside, and Kalona. The study is intended to see how the technology handles things like sharp curves, gravel, weather, and farm equipment on the roads.

The Iowa study will have a significant focus on how AVs will improve mobility for aging populations in rural areas. If the industry can address the concerns of this cohort, it will go a long way towards building support and demand for the technology.  

LIABILITY AND THE PANDEMIC

One of the issues which has supposedly held up negotiations on an additional federal stimulus package is the issue of liability. Whether it be employers looking for immunity as they push workers to come back to work or institutions like colleges, the issue of liability is emerging as a major point of contention. A recent piece in the Boston Globe shed light on the effort by higher education institutions to protect themselves from liability claims from students who return to campus while the pandemic continues.

The story cited numerous examples. Bates College in Maine requires students to assume “any and all risks that notwithstanding the college’s best effort to implement and require compliance with these prevention and mitigation measures.” any and all risks that notwithstanding the college’s best effort to implement and require compliance with these prevention and mitigation measures.” The state university system of New Hampshire has asked students coming to campus to sign an informed consent form. 

Alternative approaches are being taken by some schools. Northeastern University is asking students to sign a commitment to wear masks, report any symptoms, and abide by the school’s testing and quarantining requirements. Boston University is not requiring students to fill out risk or liability waiver forms or agreements. The actions come in the wake of the American Council on Education’s  letter to Congress asking for targeted and temporary liability protections to ward off “excessive and speculative lawsuits.”

The debate comes as The University of North Carolina at Chapel Hill announced that it was reversing its plan to conduct in person classes. One week into the new semester, 177 cases of the dangerous pathogen had been confirmed among students, out of hundreds tested. Another 349 students were in quarantine, on and off campus, because of possible exposure to the virus.  Three dormitories and a fraternity house developed clusters.

UNC will allow students to leave campus housing without penalty. The dean of public health said, “We have tried to make this work, but it is not working.” UNC is housing about 5,800 students in campus housing — less than two-thirds of capacity — with many more students living off campus.

As the week went on, the perils of the in person approach became clear. Notre Dame was one of the schools to take an aggressive position towards school reopening (and football) but that has blown up in its face. School opened on August 10 and now the university will go to an online only format for at least two weeks. Michigan State planned on on-campus classes but the school President acknowledged that “it has become evident to me that, despite our best efforts and strong planning, it is unlikely we can prevent widespread transmission of COVID-19 between students if our undergraduates return to campus.”

The differences in approach are yet another reflection of the lack of a national approach to so many of the issues associated with the pandemic.

JACKSONVILLE ELECTRIC MEAG SETTLEMENT

At least some of the details of the settlement of litigation between the Jacksonville Electric Authority and MEAG Power have been released. In connection with the settlement of the litigation, MEAG Power and JEA executed an amendment to the Project J Power Purchase Agreement pursuant to which MEAG Power and JEA agreed to an increase in the “Additional Compensation Obligation” payable by JEA to MEAG Power of $0.75 per MWh of energy delivered to JEA. That  Additional Compensation Obligation is not pledged to the payment of either the Bonds or the DOE Guaranteed Loan which have financed the Votgle Plant expansion

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An additional agreement grants to JEA a right of first refusal to purchase all or any portion of the entitlement share of a Project  Participant to the output and services of the Project J in the event that any Participant requests MEAG Power to effectuate a sale of such entitlement share. On August 12, 2020, JEA, the City of Jacksonville, Florida, and MEAG dismissed the litigation among the parties in both the United States District Court for the Northern District of Georgia and the United States Court of Appeals for the Eleventh Circuit. As part of the settlement, the parties agreed to accept without challenge or appeal the June 17, 2020 order of the district court determining that the Project Power Purchase Agreement is valid and enforceable.

It is hoped that after the twin failures of a botched sale of the utility and the settlement of this litigation that attention can now be paid to the management of JEA going forward. Clearly the path it was on was not favorable for investors. Management is conducted on an interim basis as the City looks for a new manager. As it stands, JEA is not really any better off than it was at the start of the process and now likely has fewer options going forward. The Votgle expansion will continue to weigh on the JEA credit for a long time and it should serve as a continuing weight holding back any real improvement in the JEA credit outlook.

RATINGS AND THE PANDEMIC

Ratings are always going to be a lagging indicator. Through their history, the worst of a massive event is often over before the rating agencies take action to lower ratings. We expect that the pandemic will be no different in that regard. So while we are not seeing widespread downgrades yet, we are seeing the signs of validation of our view expressed some weeks ago about which sectors have greater vulnerability to the limitations on economic activity which have resulted from the pandemic.

The latest action we see as strictly pandemic related is the switch in outlook for the Moody’s rating on the New Orleans Port Board of Commissioners. The current A2 rating was maintained but the outlook was shifted to negative from stable. The coronavirus pandemic has significantly affected the port’s cruise business; the current economic contraction is pressuring the port’s container and rail segments; and the port’s breakbulk business remains significantly pressured by tariffs, with throughput down 25% in the fiscal year ended June 30, and down 45% in the last five years. 

Given its location near the mouth of the Mississippi River, the Port serves a significant role in the export of commodities from the Midwest. The board operates as a landlord port authority for a deep-water, multi-purpose port complex located on the Mississippi River in New Orleans. The board’s facilities are located along 22 miles of waterfront on the Mississippi River and the Inner Harbor Navigation Canal (IHNC) and include 52 berths, 23.3 million square feet of cargo-handling area, 3.1 million square feet of covered storage area and 1.7 million square feet of cruise terminal and parking area.

Some of the pressure on the rating comes from capital spending decisions made before the pandemic existed. For example, the port is adding debt to fund capital spending, and is anticipating a robust recovery in cruise that will enable it to match the increase in debt service over the next three years. Moody’s estimates that  lower than anticipated cruise revenue, and potentially lower cargo and rail revenue, combined with more than $7 million of new debt service by fiscal 2023 will require significant spending adjustments – upwards of $10 million, or more – in order for the port to maintain total debt service coverage ratios (DSCRs) near its target of 2.0x.

The negative outlook reflects significant uncertainty around the timing and level of recovery in cruise, continued material pressure on breakbulk cargo (goods that must be loaded individually, and not in intermodal containers nor in bulk as with oil or grain) and cyclical but steep declines in container and rail activity. The Port’s situation is an example of the sort of decisions which will be faced by port operators so long as the economy is held down by the impact of the pandemic.

DEFUNDING THE POLICE

A number of cities have tried to begin the process of “defunding the police” with local legislatures enacting budgets with cuts in budgets for local police departments. The effort comes obviously in the midst of the massive debate over policing in the U.S. As the site of some of the largest demonstrations and some of the more prominent “economic” violence incidents, New York City was at the debate’s center. Mayor deBlasio made a pledge to defund the police to the tune of some $1 billion.

So we were interested to see what actually happened in connection with the defunding movement and the budget enacted by the City for the FY beginning July 1. The City’s Independent Budget Office (IBO) has provided some of the answer to that question. IBO has compared planned police spending in the April Executive Budget with the budget adopted on June 30. This comparison only covers the police department’s operating budget, which totals $5.2 billion.

The operating budget for the police, like that of other city agencies, excludes costs such as fringe benefits and pension contributions for staff, and debt service, all of which are budgeted centrally by the city. IBO estimates that for 2021, city spending on these items will total $5.4 billion for the department and brings total police expenditures to $10.6 billion this year.

The 2021 adopted budget for the police department was $420 million less than what was planned in April. Including centrally budgeted spending for the department, IBO estimates that total planned police-related spending for 2021 fell by $472 million from April to June. The city’s financial plan for police spending in 2022 through 2024 changed even less from April to June, shrinking the department’s budget by only $83 million each year.

The largest recurring savings comes from eliminating one police academy class. Not adding 1,163 recruits reduces the police department budget by $55.0 million in direct salary expenses in 2021. Forgoing this class means that after allowing for usual attrition, the number of uniformed officers would fall to 35,007 by June 30, 2021, down from 36,263 in April 2020.

Although the Mayor’s announcement of the budget agreement highlighted the shift of school safety staff and school crossing guards—along with $350 million to pay for their salaries–from the police department to the Department of Education, other than a $6 million cut in planned school safety overtime, no sign of this shift appears in the city’s financial plan.

GREEN CULTURAL SHOOTS

Museums and other cultural institutions will be allowed to open in New York City starting on Aug. 24. Institutions will be required to keep the buildings at 25% occupancy and to use a timed ticketing system, which would allow museums to carefully regulate how many people are entering at once. Face coverings will be compulsory. The directive does not allow theaters and other performing arts venues to open.

The Metropolitan Museum of Art will reopen Aug. 29; the Met’s Cloisters site in upper Manhattan will open on Sept. 12. Other reopening dates for the city’s museums include The Museum of Modern Art (Aug. 27), with free admission for the first month. The Museum of the City of New York plans to open on that day as well. The American Museum of Natural History will open on Sept. 2 for members and Sept. 9 for the general public.

CANNABIS

A petition in Montana to legalize recreational marijuana for adults 21 and older has qualified for the state ballot in November. Initiative 190 and Constitutional Initiative 118 will be eligible for state residents to vote on. It is impressive that the ballot items qualified given the limitations of the pandemic. The initiative reportedly required 25,000 verified signatures to qualify, while the constitutional amendment needed around 50,000.

The initiative would legalize the sale and possession of limited marijuana quantities while adding a 20 percent tax on the sale of non-medicinal pot products in the state. Supporting organizations estimate that sales would generate $48 million in tax revenue for the state by 2025. Much as was the case when Prohibition was ended in the midst of the Great Depression, initial moral objections to the legalization of alcohol were overcome by the need for state revenues during a time of economic distress. Current state and local government fiscal conditions are creating a similarly based source of support for legalization of marijuana.

CHICAGO’S NEXT PROBLEM

It was big news when the City of Newark, N.J. found that it faced significant fun ding needs to remediate the health impacts resulting from the use of lead piping to deliver water to individual customers. The resulting outcry led the state and other issuers to put together a financing package to address the situation quickly without harming the credit of the City. That program is underway and the City of Newark just saw the outlook on its credit raised from stable to positive.

Now the City of Chicago finds itself in a similar position. Chicago has the most lead service lines in the United States, largely because the city’s plumbing code required the use of lead to connect single-family homes and two-flats to street mains until Congress banned the practice in 1986. The City uses chemicals in the treatment of the municipal water supply that form a protective coating inside lead pipes connecting homes to cast-iron street mains.

The City estimates that some 360,000 Chicago homes have lead service pipes. The cost of line replacement is estimated at $8-billion-to-$10-billion. That is money that the City certainly does not have. The estimates also come at a time when the State of Illinois is in no position to fund such a project and the federal government remains hostile at best to the City and to issues of environmental remediation.

It is a political nightmare. It was City regulations that drove the use of lead piping. That will make it difficult to generate support for a plan which would require customers to bear some of the funding  burden directly. A formal plan to address the problem is expected over the next few weeks but ideas are being floated in the media. The issue was debated during the campaign for Mayor but like so many other things in Chicago, it competes for funding and attention.

With each day, the perception of the City’s (let’s be honest, the Mayor’s) ability to deal with its range of pressing issues becomes less favorable. The media and political establishment are increasingly questioning the Mayor’s ability to address the multiple challenges facing the City. This is a public health issue and after Flint, MI, one that simply will not go away.

It is just one more drag on the City’s credit.

WHAT UBER’S FIGHT WITH CALIFORNIA IS REALLY ABOUT

Uber and Lyft announced that they will have to leave the California market if they are forced to comply with state laws governing their relationship with their drivers. They have been continuously litigating over their non-compliance with California law requiring them to reclassify contract drivers and grant them the benefits and protections afforded to regular employees. The companies complain that they cannot comply in time with the law and that they need at least another year to do so.

Transportation network companies have been at the center of the debate over the future of transportation, in particular the future of public transportation. The debate has been driven by the ability of these companies to artificially cap the cost of a ride. What all of these legal efforts should make clear is that the business model for these companies relies on an exploitive relationship with their drivers.

At one point, Uber tried to make the argument that “drivers’ work is outside the usual course of Uber’s business.”  The takeaway from this line of argument is that TNCs do not work if workers are paid fairly and the cost is passed to the consumer. So the question has to be asked, is the TNC model truly a viable competitor to public transit?

If the answer is not really, then transit systems need to stop cowering before these companies. Uber and Lyft’s growth in NYC came at the expense of massive increases in congestion while they subsidized the cost of rides.  History shows that private vendors have a very mixed record of success in providing public transportation.

The current model for public transit in NYC came about through the failure of the private sector to succeed in the 1960’s. Previously, a number of private companies provided bus service throughout the city. The continued resistance to regulation by the industry especially in the area of how it compensates its drivers shows just how vulnerable the current TNC model is.

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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STIMULUS CARWRECK

The collapse of Congressional negotiations over a next stimulus package is a short term disaster. Obviously, cash strapped state governments need exactly that – cash. The actions announced by the President are in many ways useless towards addressing the major concerns of state and local government. Worse, they show how damaging it is to have a President who cannot or will not learn enough to make intelligent decisions.

Take the unemployment benefit issue. The President “orders” a $400 benefit but asks the states to cover one-quarter of that. That’s in large part because the President is ignorant of the fact that the National Conference of State Legislatures has data that shows that California, Hawaii, Illinois, Kentucky, Massachusetts, Minnesota, New York, Ohio, Texas, and West Virginia have borrowed from the federal government because their respective unemployment benefits trust funds are exhausted.

That is to be expected as these funds often need replenishment during deep recessions. So it is unsurprising that those 10 states and the U.S. Virgin Island have collectively already borrowed $19.79 billion through Aug. 7. The fact that these states have already borrowed and that an additional eight states have prepared requests to borrow shows how useless the President’s idea of having states fund 25% of the proposed unemployment enhancement is. The Governor of New York is right to call the plan something akin to throwing a drowning man an anchor.

HOW’S THAT REOPENING WORKING OUT?

We don’t necessarily link these things to specific credit issues but, they serve as an indicator of what the environment supporting municipal credit generally is looking like. Obviously, the economic outlook is key. Only when it is clear as to the state of the pandemic and the economy which can be sustained under those conditions can one make valid judgments about particular credits. For now, it is a macro issue.

So let’s take a look out over the horizon as we assess the credit environment. One month after reopening, Walt Disney World is reducing its hours of operation beginning on Sept. 8, the day after Labor Day. Hours will be reduced by one to two hours per day, depending on the park. Disney reported an approximately $3.5 billion adverse impact on operating income at its Parks, Experiences and Products segment (theme parks, retail stores, and suspended cruise ship sailings) due to revenue lost as a result of the closures of those operations. 

In Georgia, one school district reopened without masks or distancing. One week in and the schools were closed for two days for cleansing and some 900 students and faculty at the schools are in quarantine. That does not bode well for similar efforts. The large metropolitan school systems are either holding class on line or are holding classes in hybrid form between in person and on line.

Rhode Island Schools were set to reopen on Aug. 31 but the new reopening date will now be Sept. 14. The final announcement of whether it’s safe for districts to reopen in person is expected the week of Aug. 31, rather than Aug. 17. The governor is on record as wanting to monitor data closer to the first day on Sept. 14 while giving school leaders more time to prepare. 

In what may be the most culturally significant action, the PAC 12 and the Big Ten have postponed their football seasons until 2021. The NCAA announced that it “cannot now, at this point, have fall NCAA championships because there’s not enough schools participating.” There was a heavy lobbying effort against such a move. It has real significance given the role of football programs as revenue producers for the schools directly. They are also huge drivers of associated economic activity. Some stadiums become among the five largest populated areas in some states on football Saturdays.

This is about operating within a realm of realism and information or operating in a delusional state.

DEBT RESTRUCTURING

The fact that municipal bond interest rates are at historic lows has created a good opportunity for troubled credits to take advantage of the rate environment to restructure debt. Last week we discussed the use of debt to relieve short term budget pressure. This week, true restructurings were back in the news.

The perennially troubled U.S. Virgin Islands will consider a plan to refinance some $1.1 billion of matching fund debt which is secured by revenues generated through the rum industry. U.S. Virgin Islands Gov. Albert Bryan Jr. announced a plan to create a special purpose vehicle that would receive the rum cover-over payments on U.S. rum sales that currently support the bonds. The new special purpose vehicle should allow the new bonds to pay at around 3.5% rather than the 6% that the current bonds are paying according to the plan. The Governor’s plan assumes that the lower borrowing costs will generate funds not needed for debt service to be applied  to pay off some of the unfunded liability of the Government Employees Retirement System (the government pension).

The City of Harvey, Illinois has been in default on $4.5 million in defaulted debt service that was due in December 2018, June and December 2019 and June 2020 on the $31 million 2007 issue. Bondholders sued to enforce payment of the bonds. The result of the proceedings has been a consent decree requiring  the county tax collector to remit 10% of all ad valorem property tax collections collected in connection with the general corporate levy directly to an escrow agent that manages a tax escrow account for bondholders. The other 90% will be transferred  directly to the city.

The agreement extends until June 2, 2022 as long as the city honors terms of the agreement that call for it to continue negotiations and move towards a debt restructuring. The agreement is not a guaranty that a resolution to the City’s debt situation will occur. Previously, Chicago sued Harvey the city fell in the arrears on payments for Chicago-treated water from Lake Michigan. The two cities agreed to a consent decree in 2015, but Harvey violated it and the court stripped Harvey of control over its water operations in 2017. The City is back in court in an effort to take back control of its water system with the proposed refinancing serving as a vehicle to pay back the City of Chicago. In 2018, Harvey  settled litigation with its public safety pension funds that sought to garnish tax revenues to make up for overdue contributions. Harvey remains in negotiation to resolve a dispute over some of its contributions still in arrears.

NEW JERSEY BORROWING PLAN

The New Jersey COVID-19 Emergency Bond Act authorizes as much as $9.9 billion of state borrowing either through the issuance of general obligation bonds with up to 35-year maturities or short-term debt through the U.S. Federal Reserve’s Municipal Liquidity Facility program. The law was challenged by the state’s Republican Party which sued to have the law declared unconstitutional. This week, The New Jersey Supreme Court unanimously ruled that the law meets the state’s constitutional provisions regarding borrowing.

The bill permits the state to borrow up to $2.7 billion by the end of the extended 2020 fiscal year on Sept. 30, and $7.2 billion for the shortened 2021 budget cycle from Oct. 1 through June 30. The decision limits the borrowing to the amount authorized. The plan is designed to fund the state in the face of a revenue shortfall estimated in May to be $10 billion. The decision is not the final step in the process which will require the Legislature to agree on estimates of revenue which will dictate the amount which will actually need to be borrowed.

The action comes as the Federal Reserve announced that it was lowering the cost of borrowing under the Municipal Liquidity Facility. While the State of Illinois has been the only borrower under the program to date, it would not be surprising to see additional states and other municipalities consider short term borrowing. The debate which played out in New Jersey could be repeated in other states if the economic recovery stalls or falters. Much will depend on whether or not Congress can legislate another aid package that includes direct assistance to state and local government. If it does not, it simply is not reasonable to take the position that the State can cut its way out of a $10 billion revenue loss.

AUTONOMOUS VEHICLES

Before the pandemic and its potentially transformative impact on work, much debate was underway over the future of urban transportation. There has been much discussion over technology and the role of government in the development of infrastructure for things like autonomous vehicles. The potential political, financial, and fiscal implications of the choices made over the next decade are enormous.

So we find very interesting the recent comments on autonomous vehicles from AAA. The AAA automotive researchers found that over the course of 4,000 miles of real-world driving, vehicles equipped with active driving assistance systems experienced some type of issue every 8 miles, on average. Researchers noted instances of trouble with the systems keeping the vehicles tested in their lane and coming too close to other vehicles or guardrails. AAA also found that active driving assistance systems, those that combine vehicle acceleration with braking and steering, often disengage with little notice – almost instantly handing control back to the driver. A dangerous scenario if a driver has become disengaged from the driving task or has become too dependent on the system.

The results will not assuage fears held by those who are reasonably wary of dependence on technology. AAA’s 2020 automated vehicle survey found that only one in ten drivers (12%) would trust riding in a self-driving car. On public roadways, nearly three-quarters (73%) of errors involved instances of lane departure or erratic lane position. While AAA’s closed-course testing found that the systems performed mostly as expected, they were particularly challenged when approaching a simulated disabled vehicle. When encountering this test scenario, in aggregate, a collision occurred 66% of the time and the average impact speed was 25 mph.

At the same time as the AAA comments were being released, a new 34-page research brief was issued by the Massachusetts Institute of Technology. It said that “analysis of the best available data” suggests that the “reshaping of mobility” around automation will take more than a decade. “We expect that fully automated driving will be restricted to limited geographic regions and climates for at least the next decade and that increasingly automated mobility systems will thrive in subsequent decades,” the report said; with winter climates and rural areas experiencing still longer transitions.

As a result, the MIT researchers concluded that AVs should be thought of as one element in a “mobility mix” and as a potential feeder for public transit rather than a replacement for it. They acknowledge that unintended consequences such as increased traffic congestion could result from the use of these vehicles. Examples cited of projects being undertaken to “encourage” AV development are mainly centered around data collection about traffic and demand patterns. We still do not see evidence that the thornier issues surrounding AV technology especially their vulnerability to bad weather are moving forward quickly enough to justify the kind of investment by municipalities sought by the industry to facilitate its rise.

The report highlights the fluidity of the environment in which the transportation debate occurs. We have always believed that technologic change would evolve gradually and that there was no clear path forward. This would support a cautious approach to financing and funding decisions by municipalities as the autonomous or vehicle sector develops. It is simply not prudent for municipalities to make the kinds of substantial investments which futurist technology proponents wish to be made. It is clear that autonomous transportation technology remains at an early stage, with development, acceptance, and widespread utilization still many years away.

PRIVATIZED STUDENT HOUSING AND THE PANDEMIC

“While the CDC may be of the belief that student housing reducing density in student housing may lower the possibility of infection, we do not believe that requires a reduction in the number of roommates that would typically be permitted in the student housing or the number of students that can be housed in a given building.”  Well that is one way for a private operator to react. It of course ignores the realities facing college administrators and the realistic fears of many students and parents.

It also highlights the double edged sword reflected in efforts to include limits on liability in the next stimulus package. For business (and that includes entities like colleges), liability protection is a big concern. For entities like student housing operators, such protection could be the difference between financial viability and bankruptcy. For students and their families, a press to return generated by these operators could perversely lead to widespread lack of demand.

Private operators have at least initially taken an aggressive approach as reflected by the opening quote.  The comments on reopening and distancing have often been accompanied by implied threats of legal action to force occupancy at these facilities. It highlights once again the unique position in which many privatized student housing projects exist.

While often located on land leased from the campuses these facilities are meant to serve, they nonetheless are not university owned. Universities often incorporate these facilities into a portfolio of housing choices available to students. What they do not do is guarantee occupancy or revenues to these project financings.  Privatized student housing deals are risk shifting transactions designed to move the risk of these projects off of university balance sheets, first and foremost. If they were “guaranteed” by the colleges than their main objective would not be met.  The risk would still be on the school’s balance sheet.

So far, when we have seen responses from private sponsors to potential limitations on occupancy and actual on campus attendance they are adversarial. Threats of litigation against colleges by these sponsors may ultimately not be realistic. The point for investors is short of an occupancy guarantee from a college clearly spelled out, these facilities are true stand alone project financings.

CONSTRUCTION DURING THE PANDEMIC

During the initial phase of lockdowns, activity on construction sites ground to a halt. It was one of the first sectors to look to reopen as the pandemic unfolded. There has not been a lot of data regarding the impact of the pandemic on building activity until recently. The New York City Independent Budget Office (IBO) has released some research on construction activity during the second and third quarters of 2020 in New York.

Guidelines first issued by the buildings department restricted construction to affordable housing projects, hospitals and health care facilities, utilities, public housing, schools, homeless shelters, and a broad category titled “approved work.” Even when a site was designated as essential, that did not necessarily mean all work on the project could proceed. As of early June, more than two-thirds of essential sites included components that were required to remain idle during the pause. Conversely, all work was permitted to continue at only 32% of the sites.

This “approved work” fell into different subcategories. Emergency construction covered construction that would be unsafe if it was left unfinished, as well as projects deemed necessary for the well-being of building occupants. Work performed by a single worker was allowed since solo work reduces the risk that an infection would spread. The Department of Buildings also approved work on sites that house, or will eventually house, a business allowed to operate under the shutdown restrictions.

Despite the restrictions, The Department of Buildings issued a total of 4,376 stop work orders and violations during the shutdown period. That is roughly half the number of violations issued by the buildings department during the same period last year, although there was an average of just 6,000 active constructions sites during the pause compared with 35,000 before the pause.

CARES ACT SPENDING COMPLICATES PATH FORWARD

In light of the crushing failure by the Administration and Congress to find a way to move an additional spending package, attention is being focused on how money distributed by the federal government to the states is being spent by the states. Opponents of large scale aid to states and municipalities (largely centered on the Republican side) cite the potential for “bailing out” poorly run blue states. So it is more than ironic that spending by three of the reddest states is at the center of a debate over how the money is being spent.

The debate focuses on what the money is being spent on as well as the potential political/policy implications of some of that spending. The CARES Act says state and local governments must use relief money to cover “necessary expenditures” incurred because of the pandemic. It says governments can’t use the money to cover costs they’ve already budgeted for, and must spend the money on costs incurred between March and December 2020. That has caused questioning if not criticism of how those monies are being spent.

Idaho’s governor  is inviting counties and cities to apply for grants — paid for with federal money — to help cover their public safety budgets. Localities that take the money must agree to keep property taxes constant next year and pass on money they would have spent on payroll this year to taxpayers as a property tax credit. Comments by supporters blow the cover away from any pretense that the program has no political motivation. “Meaningful property tax relief has been the acute focus of lawmakers for several years now,” the House Speaker said in a statement.

County prosecutors are worried their clients will be held responsible for returning misspent funds.

South Dakota officials have spent $4.7 million of the state’s nearly $1.3 billion in aid paying highway patrol officers, according to the state Bureau of Finance and Management. The state is now trying to get permission to use federal aid to cover payroll costs for other public safety positions, such as corrections officers. $45.6 million — has gone to paying unemployment benefits. But the Department of Public Safety has received more funding than any other state agency besides the Department of Health and the Board of Regents.

In West Virginia, the state has admitted that it has received more aid than it knew what to do with in terms of corona virus related expenses. “We got down to a point in time where we had $100 million and we didn’t have a bucket for it,” according to the Governor. “And we could have done one of two things. We could have just sent it back to the federal government, or try to find a way that we could use it within West Virginia and use it for our people.” The state’s legal advisor noted “a cautious approach should be taken before deciding whether to allocate [federal relief] funds to any particular project due to there being no specific mention of road or highways repairs in the list of eligible expenses set forth in Treasury’s guidance.” 

So here we have three states being run from an ideological perspective – not “poorly run blue states” – effectively making the case against additional relief merely by their actions. And the Treasury is facilitating it for states where their governors are being viewed as supportive of the President. All it is doing is helping these Governors achieve political ends which have nothing to do with the pandemic (property tax relief) at the expense of the state and local government sector as a whole. In the meantime, states and cities have been hung out to dry as they cope with the frontline costs of the pandemic without the financial support needed to fund the tasks which the Administration has effectively downloaded to them.

PANDEMIC CASUALTIES

There has been much focus on the impact of the pandemic and economic activity on credits dependent upon economic activity. One sector which has shown signs of weakness is the parking revenue space. The impact shows up two ways, The obvious one is that people are not driving to downtown areas and utilizing paid parking facilities. It has already led to downgrades in this space.

The second less obvious impact has been on the revenue from fines associated with parking. New York City offers a case study. In the weeks before the pause in March, the city issued an average of about 51,600 parking and school zone speeding summonses each weekday. In contrast, over the weeks from March 23 through May 31 the average number of weekday (non-holiday) summonses was 26,571, nearly a third fewer than during the same period last year when the daily average was about 38,400.

Seventy-seven percent of all violations issued this year from March 23 through May 31 were for speed camera violations. Only slightly under 4,600 weekday violations were manually issued. During the same period in 2019, only 13.4 percent of weekday violations issued were due to speed cameras.

Over March through May 2019, 2.8 million parking summonses were issued, for a total liability of $205.4 million. From March through May 2020, 2.2 million summonses were written for a total liability of $138.3 million—a decrease of 38%  in fines assessed from the same period in the prior year. Much of the decline in revenue is attributable to the suspension of street cleaning for all but one week from March 18 through May 31. With street cleaning suspended there was no ticketing for violations of alternate side of the street parking.

Based on past trends, the New York City Independent Budget Office (IBO)  estimates that street cleaning suspension alone reduced the total number of summonses issued by approximately 400,000 during this period, which would have generated about $21.6 million in fines.

This validates some trends observed nationwide. With the decline in the number of cars on the road, speeding was significantly increased. Parking was down all across the country. The fines and fees associated with traffic and parking violations are key components of many local budgets. The loss of these revenues has a real impact on smaller communities.

ILLINOIS DEBT CHALLENGE REVIVED

A state appeals court has allowed an activist investor to continue his legal challenge to the payment of debt service on bonds still outstanding from a $10 billion pension issue in 2003 and a $6 billion payment backlog financing issue in 2017. The plaintiff, activist John Tillman, has challenged outstanding debt from the two prior issues, asserting that they ran afoul of state constitutional constraints  of reversed a lower court’s dismissal of the case which was based on the view that the suit was frivolous and based on politic rather than legalities. The appellate court ruled that the suit could proceed at the district level.

The appeals court decision implies nothing about the legal issues raised by the suit. The ruling case simply establishes that the plaintiff should effectively “have their day in court”. Most observers believe that ultimate success by the plaintiff is unlikely but a definitive ruling against the suit would have removed all uncertainty. The state’s fiscal year 2021 (ending June 30, 2021) general fund budget includes the potential issuance of about $1.3 billion in additional backlog bonds. Whether they can be issued while the case is pending is another story. It will become a more important issue if the constitutional amendment to change the state income tax on the upcoming November ballot is not approved.

Right now all of the legal maneuverings have focused on the issue of the right to bring the suit. The law requires a petition phase prior to filing an action against officers of the state government to limit frivolous suits by taxpayers. The legal proceedings so far have related to the petition phase. There  have been no hearings on the  merits of the case.

BRIGHTLINE LOSES VIRGIN

The never ending saga of the high speed rail line in eastern Florida continues to take twists and turns. In its latest iteration, the Virgin Trains USA Florida LLC (referred to herein as “Brightline”), is the borrower pursuant to the Series 2019A and 2019B Florida Development Finance Corporation Surface Transportation Facility Revenue Bonds (Virgin Trains USA Passenger Rail Project).  Brightline is majority owned by Fortress Investment Group and that parent has announced that it will no longer use the Virgin brand following the termination of its licensing agreement with Virgin Enterprises Limited.

The move follows on the news of major financial difficulties at Virgin’s Australian airline operations which have gone into administration in Australia and into Chapter 11 in the U.S. These distractions follow on Virgin’s less than successful rail operations in the United Kingdom. The railroad will be rebranded as the Brightline. It shouldn’t be hard as the paint was barely dry on the rebranded logos on the trains when service was halted in late March.

Restrictions on social and economic activities remain in effect in South Florida through at least August 13th. Through March 25, the railroad carried a total of 271,778 passengers and recognized $6.6 million of total revenues in 2020. The project is undertaking agreements to expand its revenue base. These include an agreement to build a station on site in Disney World and to reach an agreement with Miami-Dade County for the use of its right of way for commuter service. Such an agreement could provide a steady stream of revenue to Brightline.

It is not a surprise that the affiliation with Virgin USA was not a fruitful one although its dissolution in such a short period of time was. It was always questionable as to wh3ther the Virgin affiliation was more of a marketing or packaging ploy. Its British rail affiliates lost their right to operate long distance trains in Britain after many complaints around the level of service provided. It was not clear what particular expertise Virgin would bring to the actual operation of the railroad. It certainly is not clear as to when economic conditions will return to levels able to sustain the project. So if demand is artificially depressed, it may not matter what the train is called.

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