Joseph Krist

Publisher

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This week’s stunning unemployment claims report makes a strong case in favor of a view that essentially all municipal credits should carry a negative outlook. We do not foresee a cascade of sudden multi notch downgrades but rather a steady negative trend underlying most if not all of the metrics supporting ratings. We do not anticipate significant defaults to result from the pandemic over the near term. We do anticipate that downgrades will increase impacts on trading values and raising investor concern.

For investors who plan to hold their bonds until maturity or redemption,  holding on to what have been to date sound credits makes sense. For those who are concerned with real time valuations and the potential short term trading impact, it is a different story. It is time to lighten up on some sectors (project finance – corporate backed or individual facility backed – in all sectors, private student housing, senior living to name a few) and shift to revenue backed enterprise credits (utilities – water, sewer, electric) which are better able to weather a longer term storm.

We are truly in unchartered waters. The implementation of essentially nationwide lockdown regulations has not occurred in our history. There are no good models for an economy with a 30% unemployment rate over an extended period. Current federal fiscal policies, especially those regarding taxation, have created an environment not conducive to decisive and sizeable enough federal fun ding efforts. Even with additional stimulus actions in Washington, states and municipalities will ultimately bear the financing and funding burden of recovery.

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CORONA VIRUS

“The first line of attack is supposed to be the hospitals and the local government and the states themselves.” That comment from the President highlights the unique role that the issuers in our market face. That raises the issue of why Congress has made it increasingly harder for states and localities to fund and finance their activities. The trend over the last 40 years has been to chip away at the ability of states and localities to access capital. So now the ability to use tax exempt financing to engage the private sector is limited, the ability to refinance to provide maximum flexibility to address situations like the current one is limited. All of this was somewhat acceptable when there was a strong federal structure in place to support responses to national emergencies. That is no longer the case.

The lack of such a structure has done significant current and near future damage to state and local finances. That means that stimulus 4 – and there will be a couple of more bills – will need to be the foundation to support a real federal response to the issue of the impact of the pandemic on state and local finances. So far the enacted legislation has help for the health system, people, small businesses, and big businesses. Yes, some public transit agencies will get to divide $25 billion. It has not addressed revenue and expense impacts on general governmental finances resulting from that first line of attack standpoint. It also does not deal with toll facilities which are experiencing significant lower use and revenue.

So what to do when such a federal response is lacking? One has to find what evidence they can about the efficacy of social management policies which seek to combat the virus. The concern is especially heightened as all signs point to a potentially cataclysmic impact on state and local economies and fiscal positions. Now we have some objective guidance to support state and local interventions.

The Federal Reserve Bank of New York has released a study of the impact of “non-pharmaceutical interventions” (MPI) implemented in response to the Spanish Flu pandemic in 1918-1919. It’s primary findings indicate that areas that were more severely affected by the 1918 Flu Pandemic see a sharp and persistent decline in real economic activity. Second, it found that early and extensive NPIs have no adverse effect on local economic outcomes. On the contrary, cities that intervened earlier and more aggressively experience a relative increase in real economic activity after the pandemic. It was true that the 1918 Flu Pandemic led to an 18% reduction in state manufacturing output for a state at the mean level of exposure. Exposed areas also see a rise in bank charge-offs, reflecting an increase in business and household defaults. It also notes that the effects lasted for up to four years after the pandemic.

On the local level, cities that intervened earlier and more aggressively experience a relative increase in manufacturing employment, manufacturing output, and bank assets in 1919, after the end of the pandemic. The effects are economically sizable. Reacting 10 days earlier to the arrival of the pandemic in a given city increases manufacturing employment by around 5% in the post period. Likewise, implementing NPIs for an additional 50 days increases manufacturing employment by 6.5% after the pandemic.

The 1918 Flu Pandemic lasted from January 1918 to December 1920, and it spread worldwide. It is estimated that about 500 million people, or one-third of the world’s population, became infected with the virus. The number of deaths is estimated to be at least 50 million worldwide, with about 550,000 to 675,000 occurring in the United States. The pandemic thus killed about 0.66 percent of the U.S. population. The pandemic came in three different waves, starting with the first wave in spring 1918, a second wave in fall 1918, and a third wave in the winter of 1918 and spring of 1919. The pandemic peaked in the U.S. during the second wave in the fall of 1918.

What else can the study tell us about the economic and fiscal risks which result on a more specific basis? One thing is that the employment and output declines in high exposure states are persistent, and there is limited evidence of a reversal, even by 1923. Most U.S. cities applied a wide range of NPIs in fall 1918 during the second and most deadly wave of the 1918 Flu Pandemic. The measures applied include social distancing measures such as the closure of schools, theaters, and churches, the banning of mass gatherings, but also other measures such as mandated mask wearing, case isolation, making influenza a notifiable disease, and public disinfection/hygiene measures.

Other research supports the continuation of social and economic measures by state and local governments. A working paper from University of Chicago researches estimates that moderate social distancing would save 1.7 million lives between March 1 and October 1, with 630,000 due to avoided overwhelming of hospital intensive care units. Using the projected age-specific reductions in death and age-varying estimates of the value of a statistical life (VSL), we find that the mortality benefits of social distancing are over $8 trillion or $60,000 per US household.

The bottom line is that there is no quick answer to how best to handle the pandemic but there is clear evidence that a strong and timely approach is the best way in both the long and short run. There is no way for states and cities to avoid a significant fiscal hit at least in the short run. New York State will not have a timely budget and many other states are likely to have the same experience. It is also likely that good and timely information will not be available to legislators trying to enact budgets. At the same time, the closures of many public offices will delay the aggregation and distribution of complete and timely financial disclosures to all municipal finance stakeholders. 

CORONA VIRUS INFECTS RATINGS

This week the impact of the corona virus began to be seen in a variety of ratings actions. These actions all occurred in sectors which we have recently highlighted as being vulnerable to the revenue impacts of the corona virus. In the hospital sector, Moody’s Investors Service has placed under review for possible downgrade the ratings of four Washington hospital districts and one California healthcare district due to anticipated financial stress stemming from the coronavirus outbreak. This action affects approximately $214.7 million of rated outstanding general obligation bonds and $19.9 million of rated outstanding general obligation limited tax bonds.

The state general obligation sector saw Moody’s Investors Service has affirmed the Aa3 on the state of Louisiana’s outstanding general obligation bonds but revised the outlook to stable from positive reflecting the impact of the novel corona virus crisis on the state of Louisiana and its expectation that there will be substantial impacts of the crisis on state finances and the economy which will dampen the positive trajectory the state’s finances have been on for the past several years. Moody’s revised its outlooks on both the State and the City of New York to negative from stable, citing the severe strain from the pandemic. We would expect similar actions on credits in the hard hit states. Likely candidates include the State of Michigan and Detroit, Illinois and Chicago, Louisiana and New Orleans.

On March 25, 2020, Moody’s placed the Government of Guam’s general obligation bonds (Ba1) on review for possible downgrade. It also has placed the Baa2 ratings assigned to the Port Authority of Guam’s port revenue bonds on review for downgrade. has affirmed the Baa2 ratings assigned to Antonio B. Won Pat International Airport Authority, Guam’s (GIAA) senior general revenue bonds. The rating outlook has been changed to negative from stable. The actions reflect  a significant reduction in visitors to the territory from Asia as a result of the Corona virus (COVID-19) pandemic, uncertainty about the timing of and speed of a recovery in visitor arrivals, and the impact of the downturn in visitors on the Port Authority of Guam’s revenues as well as general government revenues.

Now we have evidence of predicted impacts on travel related credits. Moody’s Investors Service has affirmed the Baa2 rating on approximately $50 million of Taxable Revenue Bonds, Series 2005 (Rental Car Facility Project at Ted Stevens Anchorage International Airport) issued as special and limited obligations of the Alaska Industrial Development and Export Authority. The outlook has been revised to negative from stable. Moody’s said that the negative outlook reflects our view that rental car transaction days will decline significantly over the next 12 months, resulting in narrow or less than sum-sufficient net revenue DSCRs along with the potential for draws on project reserves. The negative outlook also incorporates uncertainty regarding the project’s ability to adapt its revenues and capital expenditures in a timely manner and the risk that the path to recovery may not restore coverage or liquidity to satisfactory levels.

STATE REVENUE IMPACT

The Illinois General Assembly’s Commission on Government Forecasting and Accountability (COGFA), has released a report which estimates the potential impact on Illinois’ revenues. It based its projections on declines in tax revenues experienced during recent recessions. The conclusion: Illinois’ general operating revenues could fall between almost $2 billion and more than $8 billion over several years, depending on the severity of the virus-triggered recession. Before the crisis, COGFA had estimated that General Funds revenue would total $40.6 billion in fiscal year 2021, which begins on July 1, 2020.

COGFA’s report said the downturn between FY2001 and FY2003 saw overall General Funds tax revenues fall by a combined $1.3 billion, or 5.5%, from $24.1 billion to $22.8 billion. The three main State-source revenues—individual income taxes, sales taxes and corporate income taxes—declined by a similar 5.7% during the period. A recession of like magnitude would be expected to reduce total General Funds revenue by close to $2 billion over the next several years, according to COGFA.

According to the Commission, the Great Recession that began in December 2007 and officially ended in June 2009 saw overall General Funds revenues fall by $2.6 billion, or 8.7%, from $29.7 billion to $27.1 billion. The major State-source revenues declined by a combined $3.2 billion, or 16.6%, from $19.4 billion to $16.2 billion, but the effect was mitigated by federal stimulus funding through the American Recovery and Reinvestment Act. Due to recent income tax increases beginning in 2011, these revenues have grown from about 60% of the total to nearly 78%, according to COGFA. As a result, a recession similar to the Great Recession is expected to result in a decrease of about 11% in total receipts over several years, or a revenue loss of about $4.5 billion.

Pennsylvania reported that general fund revenue dropped 6.2% in March. Fiscal year-to-date general fund collections total $25.3 billion which is $45.6 million or 0.2% below estimates. Withholding of income tax and sales tax are below estimates in March by $20 million and $24.2 million. Keep in mind that sales tax collections are effectively on a one month lag as 60% of the sales tax remitted in March was for retail sales in February. State officials had expected payments of personal income tax to total about $2.1 billion during April, May and June but that will not happen as the tax payment  date has been moved to July 15.

THE STOCK MARKET AND PUBLIC PENSION FUNDING

One of the concerns to emerge from the current crisis and its impact on the stock market is the potential for serious negative consequences for the nation’s public pension funds. One major pension fund investor is New York City which reports that at the end of 2019, the five plans that compose the retirement system held $153 billion in assets on behalf of city workers. Extraordinarily low interest rates for government bonds in recent years have compelled pension plans to rely more heavily on equities as well as alternative assets—like hedge funds, “high yield” debt, and real estate—to increase returns. The City’s Independent Budget Office (IBO) has provided one of the first estimates of the potential impact of the stock market’s recent gyrations on pension funding.

The analysis only covers the five city funds but it outlines many of the issues which will confront pension fund managers in light of the pandemic’s impact on the economy. Assuming the NYC system met its 7% return on assets benchmark in the current fiscal year, the pensions’ assets would add approximately $10.7 billion in value. The amount owed to the pension system resulting from investment returns that fall short of 7 percent  (the assumed rate of return) is phased-in over the next seven years. Because the start of payments is lagged by one year, the first budgetary impact of losses experienced by the funds’ investments in 2020 would not be felt until 2022.

The dollar impact is potentially substantial. IBO notes that during the Great Recession of 2008, the pension system’s investments saw asset values decline by over 20% in a single year. Scaling to today’s assets, a 20% decline in value for the current year would mean the system would require an additional $41.2 billion to be made whole. The single-year losses realized by the pension system in 2022 would be $5.8 billion, resulting in an additional employer contribution of $386 million for each of the next 15 years. The city now contributes about $10 billion annually to the pension system. 

We would expect that similar data could be generated for any number of other public pension funds. The current investment experience will therefore be a drag on credit performance for some extended period. Thus the need to fund pensions will compete to a higher degree with other capital needs. The price for the lack of a coherent approach to infrastructure funding over the past three years will increase in light of the need to fund pensions and other new costs which will result from the pandemic.

HOSPITALS TRY TO MANAGE THE SURGE

Bon Secours Mercy Health will furlough its employees if their work doesn’t involve treating COVID-19 patients. It operates hospital and nursing care services in the States of New York, Maryland, Virginia, Kentucky, South Carolina, and Florida. The system is projecting it will suffer operating losses of $100 million per month without serious non-patient care reductions in headcount. Furloughed employees will be paid through April 3, and the health system will then pay out any personal time off (PTO) those workers have accrued. They will be eligible for enhanced unemployment.

The move comes at the same time its outstanding debt was upgraded  and assigned an  A1 rating by Moody’s. Moody’s based the change on BSMH’s strong liquidity of over $5 billion, centralized management model and platform, and proven ability to quickly execute complicated integration strategies, which will provide resources to manage through COVID-19 challenges. Governance considerations include the successful execution of system-wide integration initiatives over the last 18 months, consolidated management structure, and a common IT platform, all of which will drive a second year of sizable synergy benefits. Strong liquidity from $1.2 billion asset sale proceeds, upcoming asset sales, and expected bank line availability will provide flexibility during COVID-19 operating stress and for long-term growth strategies.

It is just the latest example as hospitals seek to shift the cost burden of stay at home policies to the government. The implementation of restrictions of non-emergency care has a significant impact on their revenues from non-governmental private insurance payers. There is also far less need for the many administrative personnel usually needed to service the existing insurance scheme in the US. The layoffs and cost reductions are the primary tool at the disposal of hospital managements as they navigate a high cost limited reimbursement environment in their effort to maintain as positive a credit profile as they can.

STATE BUDGETS ADAPT TO VIRUS REALITIES

Gov. Andrew M. Cuomo announced an agreement with the Legislature on a $177 billion budget. The pandemic led to a plan which includes lots of hopeful assumptions, increased borrowing power through the relaxation of statutory debt limits, and gives the Governor unilateral flexibility to make budget cuts through the end of Fiscal year 2021.

As is the case in many states, budget negotiations are intertwined with non fiscal policy issues. The impact of the pandemic created an atmosphere of urgency to get a fiscal framework in place as the state deals with its role as the pandemic epicenter. This meant that several such policy issues which might have led to a different budget outcome on both the revenue and expense side were set aside to facilitate a budget settlement.  

New Jersey will extend the state’s deadline for a new 2021 fiscal year budget to Sept. 30 from June 30. It is the first state to do so. “This will allow the administration and the legislature to focus fully on leading New Jersey out of this crisis, and to allow for a robust, comprehensive, and well-informed budget process later in the year,” according to the Governor and the leaders of the state legislature. It would not be a surprise to see other states follow suit as the national stay at home periods continue over what is typically the quarter when states receive their highest proportion of revenues.

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.