Joseph Krist

Publisher

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ISSUE OF THE WEEK

$173,500,000

FLORIDA DEVELOPMENT FINANCE CORPORATION

SOLID WASTE

DISPOSAL REVENUE BONDS

(SOUTHEAST RENEWABLE FUELS, LLC PROJECT)

Coming to a high yield portfolio of yours could be a piece of this issue. This meets all of the traits of a muni high yield deal complete with (for many investors) a less familiar technology and product, a bit of speculation, construction risk, commodity price risk, and operating risk.

The project is designed to convert waste fiber from a variety of sources: biomass, sugar cane waste, and sorghum. The plant will take the fiber product and convert it into pulp usable to produce certain forms of paper packaging. Currently, the technology is in operation in Asia and Europe but is still in the construction stage in the US.

Revenue for the project and ultimately payment of debt service will be produced through the sale of the final pulp product. A contract with an entity to distribute the product is in place and that party guarantees to purchase amounts equal to some 38% of the project’s capacity.

As is always the case with these projects, the risk is borne by the investor. It is a true project financing with the only revenue available for debt service derived from the operation of the facility and sale of the product. There some performance guarantees but there are no direct financial guarantees. All of this is reflected in the Limited Distribution to Qualified Investors and $100,000 minimum denominations.

In reality these Qualifies Investors will largely be representing retail investors who may or may not understand what they own.

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AIRPORT BONDING NEEDS

The Airports Council International has released the results of a survey of the capital needs facing airports in the United States. In 2017, 1.7 billion passengers and 31.7 million metric tons of cargo traveled through U.S. airports. The Council estimates that America’s airports are facing more than $128 billion in new infrastructure needs across the system and a debt burden of $91.6 billion from past projects. That’s about a 28 percent bump up from ACI-NA’s last study. The Council uses their data to support increases in PFC’s. The Council cites the fact that the PFC cap – last adjusted in 2000 – has seen its purchasing power eroded by 50% in the past two decades.

The Council takes the position that modernizing the federal government’s PFC cap is the simplest and most free-market option for providing airports with the locally controlled self-help they need to finance vital infrastructure projects. They view PFCs as locally generated revenues used for “local” projects. The airline industry to say the least disagrees. Airlines for America takes the view that “PFCs are nothing more than a tax on travelers — a tax that isn’t needed considering there’s almost $7 billion in the Aviation Trust Fund which airports can access.”

The debate comes in parallel with the debate being played out in the Congress. The House Transportation Committee chair and Aviation Subcommittee co-chair are on the record in favor of an increase in the cap on PFCs. “A number of airports are bonded out, and in order to issue new bonds and do additional capacity or terminal work,” they need the cap raised, Chairman DeFazio said. “And we’re still working on the details of what that might be.” The subcommittee chair mentioned hiking the cap to $8.50. It’s now $4.50 per flight segment.

O’HARE HYPERLOOP DYING ON THE VINE

One immediate result of the Chicago mayoral race is that the future of the O’Hare hyperloop project was a loser along with the fifteen candidates who did not qualify for the runoff. In June, Musk and his Boring Co. were selected to build the underground tunnel system where passengers would be transported between Block 37 in the Loop and O’Hare Airport in just 12 minutes each way. On its website, Musk and The Boring Co. said that passengers would be transported by electric skates that can travel at speeds of up to 155 miles per hour. “It will take 12 minutes to travel from O’Hare to downtown. The Chicago Express Loop is three to four times faster than existing transportation systems between O’Hare Airport and downtown Chicago.” 

Neither of the two candidates remaining in the race is viewed as a supporter of the project. It is true that the project as proposed by Musk would be 100% privately funded. The reality is that the project is competing for political bandwidth along with issues like taxes, schools, public safety, and pension funding.

CANNABIS IN ILLINOIS

One of the sources of potential new revenue for the State of Illinois is the tax revenue which is expected to be generated from the legalization of recreational marijuana. Proponents were heartened by the release of the results of a survey commissioned by the state legislature. A private sector consultant has developed data around the issue of demand and the industry’s ability to meet that demand and enable the legal market to overtake the illicit market.

That study showed that demand could be as high as 550,000 pounds a year, far more than the state’s licensed growers can supply. The 16 licensed growers in the state would take issue with that. The study projects demand based on information generated from a survey of those who were willing to respond and ‘admit” current marijuana use. The survey says current growers could meet only 35 to 54 % of demand if recreational marijuana were legalized.

The study follows one conducted by Illinois NORML which says the state has the most expensive marijuana in the country and is already seeing shortages of some products for medical customers. That study suggested licensing more cultivators and allowing existing dispensaries to begin growing marijuana, since they have already been vetted and authorized by the state to handle the drug.

The findings will be seized upon by those who believe that the issues of incarceration resulting from past drug law enforcement should be addressed through the licensing of many smaller growers and distributors. If the expected market were fully met, the report says, the state could collect at least $440 million annually in tax revenue. Sponsors of a bill to legalize recreational cannabis have said they plan to introduce a proposal in March or April. If it becomes law, recreational sales might not start until 2020.

The issues at play in Illinois are being replicated across the country. The idea of conflating marijuana legalization with the issues of judicial and correctional reform, and the emerging issues of reparations has seriously compromised debate on the issue. These factors are holding up legalization for recreational purposes in New York and New Jersey.

THE CREDIT IMPACT OF THE DECLINE OF COAL

Much of the focus of public opinion on the issue of coal consumption and its role in climate change is on the environmental aspect of the issue. For municipal investors, the decline of coal has other consequences. The immediate impact of declining coal production is the decline in the level of revenues derived from severance taxes. In Kentucky, state government collects the coal severance tax and makes distributions to counties. Supported spending includes  road maintenance and construction of 11 regional industrial parks, education programs, mine safety research and workers’ compensation for injured miners, water and sewer infrastructure, and facilities like senior centers, community centers, and cemeteries. Localities also used a portion of the coal severance tax to pay for law enforcement, and waste management. 

Now the counties and localities are feeling the pinch. In 2012, Kentucky distributed $32.2 million back to 29 coal-producing counties. That amount fell to $12.4 million in 2018 — a 61% decline in six years. In Virginia, where severance taxes are levied on coal and natural gas producers, the Virginia Coalfield Economic Development Authority, funded by a portion of the coal and natural gas severance tax, saw the tax drop 62%  from 2011 to 2017. 

For localities, the cuts have been painful. The decline in production also lowers the value of the property used in coal production. The lower severance revenue represents a double whammy for localities which face both the cuts as well as a diminished tax base against which they can generate replacement revenues. They also generate population declines which diminishes the job base and the overall economic base which generates revenues.

MOODY’S SENDS MIXED SIGNALS ON NEW YORK CITY

When Amazon backed out of its deal with New York City and State, Moody’s was quick to describe the situation as credit negative for the city. They were concerned about what message the City was sending to the tech industry and whether the City was becoming less business friendly. They expressed concern about the City’s ability  to diversify its economy going forward. So now, just a couple of weeks later, Moody’s has taken the opportunity to revisit the credit. In the interim, the Amazon deal may be showing signs of resuscitation and the City is preparing for reduced revenue growth stemming from the late 2017 federal tax law changes.

So we question the basis for this week’s upgrade of the City’s GO credit. The Mayor’s supporters are latching onto this as proof that the Mayor is managing the City responsibly. The City still faces significant capital demands, directly for its public housing stock which is now being operated under a consent decree by a temporary manager. It can expect to be called upon to make significant additional funding actions to support the MTA’s massive capital plan.

The issues cited – strong financial management and steady improvement in its financial position that reflect greater flexibility to react to the next downturn – were questioned this week by the City’s Controller who questions the City’s reserve position in the face of a growing consensus around a recession occurring by 2020.  The report references lower benefit costs but simultaneously expresses concern about rising healthcare expenses.

It is confusing to say the least. Given where the State and City are in their budget processes, the upgrade might make more sense once those processes are completed and a clearer picture of the economic outlook emerges. It might also makes more sense if it did not accompany real questions about recent new spending on education and mental health which clearly did not and is not achieving its goals. The inability to show any tangible results for some $1 billion in new spending should be concerning to all.

EDUCATION: PUBLIC VS. CHARTER

The issue of charter schools versus public schools continues to be debated. Municipal bonds investors have the opportunity to invest in both as well as in one or the other. In determining whether to invest it is best to understand the continuing dynamic between the two school philosophies.

One of the issues which has often hindered the debate is the issue of standards and comparability. Now, California is poised to take the lead in the development of common sets of standards for both types. Last week, A proposal championed by Gov. Gavin Newsom to require new transparency standards for charter schools across California was passed by state legislators. Senate Bill 126 codifies a recent opinion from California Atty. Gen. Xavier Becerra that governing boards of charter schools should be subject to the same open-meetings laws and conflict-of-interest standards as public school districts. 

The California Teachers Assn. endorsed the measure and the charter school groups involved took a neutral position. Charter school supporters spent heavily in the 2018 election cycle in favor of opponents of the new Governor. Their lack of a position on this issue and support for two teacher job actions in large districts created the political dynamic that supported passage.

Now the state and its school systems must find ways to increase the funding needs stemming from settlement of the labor disputes.

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