Joseph Krist

Publisher

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WHAT’S NOT IN THE BILL

The emerging process of getting the American Jobs Plan through the Senate looks increasingly difficult. The focus on the source of funding – a 28% corporate tax rate – seems to have diverted attention from some potential funding sources which are not in the bill. The lack of those options could turn out to be a stumbling block as would their inclusion.

Specifically, we note that there is no carbon tax or vehicle mileage tax. We acknowledge that these are currently unpopular alternatives. But the corporate rate hike all the way to 28% will be difficult on its own. Some use of the alternative funding sources could generate the appearance of a more generally shared burden. Now, the expected funding is being used as an excuse not to look at increases state and local gas taxes.

Two bills which would result in a gas tax increase in Louisiana have run into increasing opposition because legislators expect a federal aid windfall. A proposed law to increase North Dakota’s gas tax by three cents per gallon recently failed in the Senate. The reality is that states will remain a significant funder of infrastructure.

According to the American Jobs Plan, from 2010 to 2020, the United States has experienced 145 extreme weather events, costing the nation an estimated $921 billion in damages. The President is calling for $50 billion to improve the resiliency of our infrastructure and support communities’ recovery from disaster. That’s 5.4% of the estimated cost. We know where the rest will have to come from.

WHILE WE FIGURE OUT HOW TO PAY FOR THE ROADS

Georgia has been in the news for all the wrong reasons lately. Much of it was its own doing but a dispute between two Korean battery manufacturers was not. A deadline was approaching which could have forced the Biden administration to  veto and international trade ruling. That ruling in favor of one of the firms LG was in a dispute between LG and SK Innovation over a claim that SK was using trade secrets belonging to LG to compete for the expected huge market for batteries, primarily those for electric vehicles (EV).

SK has said that a plant in Commerce, Ga., which is under construction would not be completed if the ruling was not overturned. Now in the face of a deadline to settle the dispute the companies announced a settlement.  The settlement allows for SK to continue to seek additional business which would support the completion of the construction on the Georgia plant.

Given the State’s existing problems, the loss of the plant needed to be avoided. Political interest in a settlement was high from the White House to Atlanta and across both parties. It overcame pressure from Ohio’s Governor where LG is building their battery plant. At the end of the day, batteries have emerged at the center of the issue of electric vehicles and renewable energy production.

ECONOMIC JUSTICE AND INFRASTRUCTURE

There is much debate over issues related to infrastructure and “economic justice”. That reflects the way that many roads, especially sections of the Interstate Highway System, were located and constructed in ways which impacted residents in those areas negatively. Whether through forced relocations in rights of way or the resulting divides between communities and neighborhoods, the result often left those impacted communities far worse off to the benefit of others.

The economic justice movement seeks to remedy this by forcing the issue to be factored significantly in any infrastructure plan. One of the issues often raised is the potential cost and difficulty associated with significant alterations to inner city segments of these roads. We are going to have a chance to see exactly what such a project will entail with the planned reconfiguration of I-81.

The State of New York has embarked upon the lengthy process of obtaining approvals to undertake a project which would remove 1.4 miles of elevated highway (built in 1969) cutting through the center of Syracuse, NY. The actual highway would be routed outside of the City itself and the viaduct would be replaced by a boulevard along the existing right of way.

Having matriculated at Syracuse University in the early 70’s I can speak to what an improvement in terms of overall access to all parts of downtown would result. I lived within two blocks of the highway and it was like a Berlin Wall existed between the adjacent neighborhood and the other side of the city. It hampered economic improvement for a long time.

Remedying the problem will not be cheap. The state budget includes $800 million — 40% of the project’s estimated $2 billion price tag — for I-81. The funding is from the state Department of Transportation’s capital plan. With the federal review process underway the project is already in position for federal funding for the bulk of the remaining costs including the demolition of the viaduct.

The project could serve as a template for future plans to replace infrastructure all over the country. Efforts to do this in NYC (the West Side Highway) and the Embarcadero in SF show that it can be done to good effect especially in terms of improving mobility and access. Those projects were born of necessity. This one  has moved to being a product of policy. It will be a significant test to see how these projects are financed and funded.

TRANSIT ISSUES CONVERGING IN NEW YORK

A combination of timing and circumstance are putting NYC at the center of the emerging debate over transportation and the role of private vehicles. It is a debate characterized by over the top passions and heated rhetoric. So we took a look at some data points we have seen lately and we see the potential for real clashes among visions and ideas.

For example, the upcoming primary elections in NYC have provided a platform to an entire range of ideas for changing day to day street activity patterns especially in  Manhattan. On one side are people who for a variety of valid reasons who truly need a private vehicle. This is especially true given the reality of the inaccessibility of the City mass transit system. Given the significant role of Manhattan as a medical center, this will be the case for a long time. On the other side are what can fairly be characterized as the anti-car crowd.

They would flat out ban individual private vehicles and put everyone on a bicycle through their entire life span. The want significant capital spending on bike infrastructure and to do it the expense of cars. But they want to fund mass transit through congestion pricing. You need cars to pay the fee so if that revenue does not materialize, how to pay for the infrastructure for other modes?

While the debate unfolds, several traffic trends are emerging. Mass transit patronage continues to significantly lag pre-pandemic levels. At the same time, the first ten days of April have seen the highest level of usage in an April on MTA bridges and tunnels since 2014. Registrations in the city for cars, trucks and other vehicles rose by 9% in December compared with the final month of 2019, according to the New York State Department of Motor Vehicles.

So what is a policymaker to do? It appears that the short run restoration of the economy supports maintaining as many points of access to the City as possible? Do the long limited businesses dependent upon suburbanites and tourists want to see any limits on access to their businesses? The inherent conflicts between peoples hopes and the realities on the ground seem clear. The City needs people to return and it needs to facilitate their return. Whatever the answer is, municipal bond issuers will be asked to accomplish them.

GREEN MUNICIPAL POWER IN OHIO

The Columbus Division of Power is a full-service, publicly owned electrical utility that provides power to industry, business and residential customers through its own distribution system in the City of Columbus, Ohio.  In November, 2020 the voters approved a ballot initiative which required the system to obtain its power from 100% renewable generation sources. The City put out a request for proposals and received four bids. It’s new supplier will begin delivering power on July 1.

It is a great example of how municipal utilities can take a leading role in the effort to decarbonize. The City has been a leader in the evolving transportation space with testing occurring right now of autonomous vehicles for public transit. Now it has reached an agreement with a renewable energy which will allow the City, initially through a combination of sourcing and energy credits, to meet the 100% renewable threshold.

PUERTO RICO

A private consortium is scheduled to take over the Puerto Rico Electric Power Authority’s (PREPA) transmission and distribution system and customer services on June 1.  As part of that process, the consortium had to submit a budget for review by regulators. The budget is reviewed to see if it reflects current rates and revenues. This week it was announced that the submitted budget was incomplete. The effort was part of a process that began last June whereby the transmission and distribution network management would be taken over.

As a part of the 15 year management agreement, the consortium must show how it can operate for at least the first three years without a rate increase to consumers. The utility regulators are charged with determining if that is indeed the case. The issue of rate increases is a “third rail” politically so the budget requirement is real. It is needed for the regulators to determine if services can actually deliver promised service improvements within the current PREPA rate structure.

Assured Guaranty (AGO) and National Public Finance Guarantee have announced an agreement in principal on the bonds from the Highway Authority and how to handle money the central government had “clawed back” from these authorities. The “claw back” provisions had long existed as an element of the ultimate security for the bonds but many investors saw the lack of previous use of these provisions as something to consider as more of a theoretical risk than a real financial risk.

To address that issue, the Commonwealth and the bond insurers reached an agreement that would provide holders of currently outstanding the Highways and Transportation Authority debt of $1.245 billion in current interest, capital appreciation, and convertible capital appreciation bonds and a cash payment of $389 million. Holders of Convention Center debt will receive $112 million in cash. The debt being offered to the HTA holders would have an average interest of 5.0% and maturity up to 40 years.

Effectively, the insurers are the bondholders and they have been paying out debt service on the bonds. Their loss is now reduced from some $4.6 billion of debt principal (and the interest thereon). It was sufficient enough to generate an agreement. The agreement covering these revenue bonds was an important component of the total Plan of Adjustment under consideration in the Commonwealth’s Title III proceedings.

This agreement creates a “Contingent Value Instrument” which is a mechanism to allow the insurer creditors to benefit from any outperformance of the agencies’ revenue streams. The agreement provides that If Sales and Use Tax collections exceed  totals projected by the May 2020 certified fiscal plan in years one through 22 the first $100 million of the better than expected revenues would go to holders of the GO bonds. The next $11.1 million would go to the creditors (the bond insurers) who were impacted by the clawback. After that $111.1 million of revenues is distributed, the clawback creditors (revenue bond holders) would get 10% of the available payment.

The real importance is that another hurdle has been overcome in the process of restructuring the Commonwealth’s debt.

STATES

The stimulus passed earlier this year continues to generate positive ratings trends for state general obligation credits. Connecticut is the latest beneficiary of this trend. It’s GO rating was upgraded to Aa3. Moody’s cites the accumulation of reserves and the better than expected fiscal results the state achieved through the pandemic. The same issues with the state economy and distribution of income and wealth in the State are still a negative issue as they were on the state’s journey downward on the ratings scale. Pension funding remains a significant issue for the State.

One of the other most challenged states when it comes to pensions is the Commonwealth of Kentucky. Recent legislation enacted in the Bluegrass State provides for changes in the state’s pension system for its teachers. The legislation creates a new tier of pension benefits for new employees. That tier will be granted a “hybrid” pension plan split between a defined contribution component and a defined contribution component. New employees of K-12 school districts and certain state universities will contribute 9% of their salaries toward defined-benefit pensions, 2% to a defined-contribution account and 3.75% for their retiree healthcare benefits, making a total contribution of 14.75%. Employers will make a total contribution of 13.75%.

Tiering of pensions has long been the practice in New York State. Say what you want about the Empire State but pension funding has always been a priority.

Tiering can get around the issue of limits on the ability of government to alter pension benefits. In many states, these benefits are constitutionally protected. Under a tiering system, existing employee benefits are not changed so there is no loss to existing employees. Objectively, it is a surprise that more states do not at least explore the potential for tiering. Leaving existing benefits in place makes for an easier discussion.

PRIVATIZED STUDENT HOUSING

The private student housing space has had a clearly mixed record in terms of their success financially. Initially, these transactions were a way for universities to expand their student housing base without incurring additional debt on their balance sheets. Many of these projects were located on land leased from universities. This led many investors to assume that additional financial support from host universities would be available in the event of financial underperformance at these facilities.

Various facilities have run into trouble financially even before the pandemic. For those facilities with weak finances, the pandemic and conversion to online learning put many of these facilities in danger of defaulting on debt. Universities have taken differing paths in terms of how they respond to these facilities and their debt problems.

One of the more aggressive adopters of the private student housing concept has been Texas A&M University. It has some 9 projects to provide student housing through private developers. They have been impacted to various degrees in terms of occupancy and revenues. Now, Texas A&M has decided that it was in their interest to purchase 6 of these projects on its campuses from the private developers. An agreement has provided an opportunity for A&M to use the current low rate environment to its advantage and issue taxable debt to be retired through the application of sale proceeds to the redemption of debt issued for the projects.

The purchase price of the six TAMUS properties was the amount needed to pay off the New Hope bonds plus interest and other accrued charges. The purchase was funded through the issuance of taxable debt the proceeds of which were applied to the purchase. The ability of traditionally tax exempt bond issuers to use taxable debt increased substantially especially in the last year as rates remained low enough to justify a taxable refunding. Without the ability to advance refund debt on a tax exempt basis, taxable debt is the most practical way to restructure debt.

This transaction is not indicative of a large scale move away from private student housing. In this case, the deal only included underperforming assets. This is reflected in the fact that A&M will continue its relationship with the developer at three additional operating dorms.

PREEMPTION

The move to allow states to preempt the right of local and county governments to regulate the use of natural gas in their jurisdictions continues. This week Iowa and Kansas became the latest states to enact laws to that effect. The Iowa Environmental Council and organizations representing cities and counties opposed the bill.

In Kansas, the Energy Choice Act has been enacted which says no Kansas municipality can put a ban on the use of natural gas. Interestingly, it was enacted without action by the Governor who was not required to sign the law. The bill passed with veto proof majorities. Given the role of Kansas as a major source of natural gas, opposition from industry was expected. It does complicate efforts to decarbonize at the local level.

It matters as a practical impediment to efforts to address climate change. For the municipal market, it creates issues for ESG investors . Policies which slow decarbonization from an ESG perspective should incur a borrower cost. As for preemption, there should be a price to be paid for the reduction of control through preemption. The whole point of issuing debt (mostly green bonds at present) as ESG debt is to receive a lower cost of borrowing so it makes sense that issuers covered by the kind of preemptive  under consideration (approximately 9 in other states) receive a higher borrowing cost if you are really trying to motivate policy.

When we get to that point, where universally accepted standards exist and investments can be made and valued on a less subjective basis, ESG investing will become a much more serious investment category. Without those standards, it will be cynically viewed as a marketing tool rather than a real difference making tool.

A further limit on the powers of a municipality to manage its finances is moving through the Texas Legislature. Senate Bill 23 passed by a vote of 28-2. If passed by the House, the bill would require that local governments “hold an election in accordance with this chapter if the municipality or county proposes to adopt a budget” that cuts police funding, allocates funding from one agency to another or reduces the number of police on a force. It is intended to be a firewall against the defund the police movement.

Given the significant role police costs play in terms of both current budget balance and the liability side for pensions balance sheet, the law presents a real limit on a municipality’s ability to manage what is often a significant expense item. The legislation was motivated by the City of Austin’s decision to reallocate city funds to different functions away from the police.

DEBT TO BAILOUT THE SOUTHWEST POWER DISASTER?

The Oklahoma Legislature is considering a bill to authorize the issuance of securitized debt to pay off the massive charges incurred as the result of the winter storm which hit the southwest at the end of February. The proposed legislation would rely on the issuance of bonds to pay off utility obligations. In return, consumers would see a tariff added to their monthly bills that could potentially last a decade. The utility would collect that charge from the consumer to repay the bond. The tariff is legally sacrosanct from bankruptcy.

It is a concept used by other utilities including large municipal bond issuers like the Long Island Power Authority in the taxable market. We will see if this becomes a viable alternative to the large Texas municipal systems if their efforts to lower charges through litigation do not bear fruit. The Oklahoma Corporation Commission’s public utility division, has stated that ahead of the winter storm the average Oklahoman paid $104.84 for their natural gas bill. Without any intervention by the state, their post-storm cost would balloon to $1,967.23 in the first month and about $1,230.83 a month for months two through eight.

The option would also be available to wholesale generation providers that sell power to municipal utility distributors, such as the Grand River Dam Authority, the 42 Oklahoma Municipal Power Authority members, and rural electric co-ops throughout the state.

In contrast, Colorado electric customers including municipal bond issuing school districts and distribution utilities are getting bills impacted by the massive power cost spikes. Utilities including the municipal utility in Colorado Springs are said to be seeking recovery of gas charges due to the storm over a two year period. The state is expected to conduct a significant investigation into the practices of the Colorado utilities in response to the storm.

One municipal was cited for a good response. Platte River Power Authority,  a municipal distributor serving Fort Collins and northern Colorado, handled a shortage in backup gas generation supplies by asking customers to turn down thermostats on Feb. 14. The power authority has said customers cut their demand enough that no blackouts were necessary. 

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.