Joseph Krist

Publisher

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PREEMPTION AND LOCAL RATINGS

As ESG investing has its turn in the spotlight accompanied by rating agencies debating the merit of scores covering these factors, governance should be an even bigger topic. The pandemic and the decline in the demand for fossil fueled energy are moving state legislatures to consider a variety of laws limiting the power of local governments to regulate a growing number of issues and challenges direct democracy.

The phenomenon of “home rule” and the resulting limits on a locality’s ability to enact regulations, tax increases, or even the enactment of new taxes has long been a factor in municipal credit analysis.  When such laws have limited a locality’s ability to raise revenues or forced them to turn to the voters for approval of taxes, the resulting inability to raise revenues has been a basis for downgrades.  The reliance on higher levels of government for approval of steps which allow localities to manage their affairs is something that should raise the ire of rating agencies and investors alike.

Now legislatures at the state level are going farther in their effort to support certain industries even in the face of declining local support. We see the activity in two primary sectors – climate change and voter initiatives. In the area of climate change, in 2020 the Arizona legislature enacted a law that prevents municipalities and counties from banning new gas infrastructure and hookups and Oklahoma, Tennessee and Louisiana also passed preemption laws regarding natural gas. 

Now, the American Gas Association is building on those 2020 successes to back similar “preemption” legislation in 12 mostly Republican controlled legislatures – Arkansas, Colorado, Florida, Georgia, Indiana, Iowa, Kansas, Kentucky, Missouri, Mississippi, Texas, and Utah. So much for the party’s historic stance on local control always being better. A new Montana bill in the legislature would prevent local governments from “imposing carbon penalties, fees or taxes” based upon carbon use. It comes as the city and county of Missoula, and the cities of Bozeman and Helena, formally adopted a joint agreement this month to work with NorthWestern Energy in developing a green tariff.

The effort comes as the market, in terms of fossil fuels, has essentially already voted on the topic. The current debate comes as the U.S. Energy Information Administration is projecting that the levelized cost of electricity is coming down for new utility-scale onshore wind and solar photovoltaic (PV) projects to levels below all fossil or conventional fuels including combined cycle gas turbine (CCGT) power plants. It makes the fight against movement away from fossil fuels more irrational.

It is a real issue. By late January, 42 California cities had taken action to limit gas use in new buildings. Seattle just took that step.  Recent research and anecdotal evidence suggests that the use of electric appliances and heating is not more expensive than natural gas. So it becomes an more an issue of ideology or resistance to change rather than sound management and local control. We see that as a governance factor which should be given significant weight in the rating process.

In the case of voter initiatives, legislatures in many of the states where the right of voter initiative and referenda is established are being asked to consider legislation limiting or outright revoking the practice. Proponents seek to prevent voters from directly considering a variety of laws. The initiative process has been key to the legalization of cannabis and the expansion of Medicaid under the affordable Care Act. Those two issues, combined with support for climate change legislation seem to be the forces driving these moves to impose control on localities.

We see the relative inability for many localities to fully control their fiscal situations to be a negative weight on credit.

THE PANDEMIC AND NEW YORK CITY

As the cultural center of the nation, New York City unsurprisingly saw major impacts as the pandemic shut down nearly all of the major cultural facilities. Now the New York State Comptroller has released data establishing just what the impact was.

In 2019, New York City’s arts, entertainment and recreation sector employed 93,500 people in 6,250 establishments. These jobs had an average salary of $79,300 and generated $7.4 billion in total wages. Some, 128,400 residents (including nearly 31,000 self-employed residents) drew their primary source of earnings from the arts, entertainment and recreation sector. As of December 2020, arts, entertainment and recreation employment declined by 66%

from one year earlier, the largest decline among the City’s economic sectors.

The arts, entertainment and recreation sector includes three subsectors, the largest of which is performing arts and spectator sports. This subsector accounted for half of the 93,500 jobs in this sector overall. The second-largest subsector, which had 32,700 jobs (35% of the total) with an average salary of $36,600, consists of amusement, gambling and recreation businesses. Museums, parks and historical sites is the third subsector, accounting for 14,300 jobs (15 percent of the total).  

Federal stimulus did help somewhat. Federal Paycheck Protection Program loans supported 62 percent of firms and 70 percent of employment in the sector. However, NYC & Company (the City’s convention and visitors bureau) estimated that nearly 67 million tourists visited the City in 2019 and accounted for $70 billion in economic activity. In 2020, however, they expect the number of tourists declined to 23 million.

MTA REPRIEVE

The Metropolitan Transportation Authority announced that major reductions would be avoided through 2022. The change in outlook reflects the high level of confidence that the soon to be approved stimulus legislation will provide significant operating fund relief to the Authority. The federal aid will be complimented by higher than projected tax revenues which make their way to the Authority.

With patronage at the MTA bridges and tunnels returning at a much faster rate than is the case with mass transit, the authority’s board also approved a plan to raise tolls at the MTA’s bridges and tunnels by approximately 7 % and to use that money for public transit. The increases will raise the one-way toll at major authority crossings to $6.55 from $6.12 for New York E-Z Pass users and to $10.17 from $9.50 for drivers who do not have a New York E-Z Pass.

Staten Island drivers benefitted for years from both a resident discount and a rebate program, will see the toll to cross the Verrazzano-Narrows Bridge rise to $2.95 from $2.75.

None of this addresses the capital needs of the overall system, especially work which continues to remediate damage from Superstorm Sandy. The $54 billion plan to modernize the system was suspended when the pandemic hit.  The Authority still faces some daunting realities. Some  five million riders used the subway on weekdays a figure which has fallen to about 1.6 million. That is a two-thirds drop. It is far from clear when and if ridership at that level returns. But the immediate heat is off and concerns about ratings and default are abated.

MARYLAND ROAD P3 MOVING FORWARD

The Maryland Department of Transportation (MDOT), MDOT State Highway Administration (MDOT SHA), and the Maryland Transportation Authority (MDTA) today announced the selection of  a private partner for the planned construction and expansion of the American Legion Bridge and I-270. The decision follows the enactment of legislation creating parameters for the P3 which sought to address issues which resulted from the ongoing Purple Line development. Those issues led to the breakup of that P3.

One of the major issues had to do with responsibility for delays and resulting cost increases arising from an extended legal review process. The legislation established limits on how much of the increased costs related to the development phase of the project. The proposal recommended by the state calls for the private partner (Accelerate Maryland Partners LLC ) to be at risk for up to $54.3 million of cost increases through the approval/development process.

The partnership consists of established P3 players in the US. Accelerate Maryland Partners LLC includes: Transurban (USA) Operations Inc. and Macquarie Infrastructure Developments LLC as lead project developer/equity; Transurban and Macquarie as lead contractor; and Dewberry Engineers Inc. and Stantec Consulting Services Inc. as designers.

In the financial proposal, Accelerate Maryland Partners offered a $145 million Development Rights Fee and a $54.3 million Predevelopment Cost Cap. Accelerate Maryland Partners also showed a long-term commitment to the American Legion Bridge I-270 to I-370 project by proposing a higher rate of return on its equity investment in exchange for taking greater construction cost risk upfront, reducing the state’s risk in the project. 

The full approval process is expected to extend through the Spring of this year.

PENN DOT BRIDGE PLAN

The Pennsylvania Department of Transportation (PennDOT) is moving towards a P3 model for its Major Bridge P3 Initiative. The Pennsylvania P3 Board approved the Major Bridge P3 Initiative on November 12, 2020, which allows PennDOT to use the P3 delivery model for major bridges in need of rehabilitation or replacement, and to consider alternative funding methods for these locations.

Now Penn DOT has announced a list of 9 bridge projects which it believes are viable as tolled facilities. The bridges being considered for the Major Bridge P3 Initiative are “structures of substantial size that warrant timely attention and would require significant funds to rehabilitate or replace. Additionally, these bridges were selected based on the feasibility of construction beginning in two to four years to maximize near-term benefits, and with the intention that their locations are geographically balanced to avoid impact to just one region.”

Tolling would be all electronic and collected by using E-Z Pass or license plate billing. The funds received from the toll would go back to the bridge where the toll is collected to pay for the construction, maintenance and operation of that bridge. Pennsylvania takes care of 41,000 miles of roads, fifth highest in the country. It’s also responsible for the third-highest number of bridges, 25,400, more than half of them at least 50 years old and 2,500 in poor condition, second highest in the country.

The plan comes as the Commonwealth is in the midst of a significant debate over funding for PennDOT.  Efforts to put tolls on sections of I-80 in 2008 met fierce resistance from local drivers and the plan as scuttled. It is likely that the tolling of existing free facilities will be met with significant opposition. At the same time, PennDOT saw a net drop in gas tax funding and the Pennsylvania Turnpike’s requirement to pay $450 million a year mostly for public transit drops to $50 million in mid-2022, and the Legislature hasn’t determined how it will replace that money.

A more comprehensive transportation funding approach in PA would be positive for holders of Pennsylvania Turnpike Commission revenue bonds. The diversion of revenues from the Turnpike to the funding of local road projects resulted in significant debt issuance to fund the annual payment requirement. That lowered debt service coverage and negatively impacted ratings. A resolution to those factors would be credit positive.

GAS TAXES

A variety of proposals are being advanced to address the need to raise revenues to fund transportation infrastructure. While Congress debates infrastructure funding at the federal level, states and localities are already trying to raise funds on their own.

Mississippi has had the same motor fuel tax of 18.4 cents a gallon since 1987. Now the Legislature is advancing a bill which would provide for the issue of a gas tax increase to be put to the state’s voters on June 8. The bill proposes a statewide election on whether to increase the gasoline tax by 10 cents a gallon and the diesel fuel tax by 14 cents a gallon.  Sponsors believe that gas tax revenues would then be able to support $2.5 billion of debt for roads.

The New Mexico legislature will consider Senate Bill 168 which would increase the gasoline excise tax from 17 cents to 22 cents per gallon. The legislature estimates that the increase would raise over $63 million annually once fully phased in by 2025, mostly for the state road fund. Only Mississippi, Missouri and Alaska have lower gas taxes. At 22 cents per gallon, the standard gas tax would still be more than 14 cents below the national average. New Mexico lawmakers have decreased the tax twice since last raising it in 1993.

The North Dakota House has passed a bill that adds another 3 cents per gallon to the state’s gas tax which has not been raised since 2005. It is currently 23 cents per gallon. The proposal also raises the annual fee on electric vehicles from $120 to $200, on hybrid vehicles from $50 to $100 and on electric motorcycles from $20 to $50.

Efforts to grapple with the growing adoption of electric vehicles continue. The Utah Legislature failed to advance legislation which would have increased six-month and yearly registration fees for owners of electric vehicles, plug-in hybrids and other alternative fueled vehicles in Utah. The defeat was based in concerns that punitive fees would discourage their purchase.

UBER AND MASS TRANSIT

The pandemic has certainly put a major dent in Uber’s business plan. They only advertise Uber Eats, the food delivery arm of the operation. revenues to the company are now derived as much from food delivery as they are from ride sharing. While it won its costly battle over how its “employees” are legally classified, it lost in England when it was ruled in the courts that its drivers “across the pond” are indeed employees.

So it is in the midst of those environmental factors for Uber that it released a “research report” about their “value proposition” to public transit agencies for Uber to become an embedded part of their systems. The effort to strike a more conciliatory tone towards these agencies marks a sharp turn from their previously adversarial stance. It reflects somewhat of a reality check in terms of the role of public transit.

“Bus, rail, and subways have dominated public transport for the last 80+ years. Those modes are here to stay – simply put, there is no more efficient alternative than high-demand trunk lines on fixed routes to move a large number of people along dense corridors. Efficient public transportation enables cities and towns to flourish by providing mobility for essential workers, older adults, people with disabilities, those who forgo car ownership by choice or by circumstance, and is the only available option by which millions of people access economic opportunities. Without efficient public transportation, cities would grind to a halt.”

At the same time, “Our estimates suggest that only about 1-6% of bus trips could be provided at a lower cost with ridesharing – a relatively modest share of overall trips.”  That sort of sums the whole problem up. In terms of the physical provision of mass transit services, they really aren’t cost competitive and as we economist like to say, produce a number of negative externalities. Whether it is over how they treat the people who drive for them, how the vehicles contribute to gridlock, and the addition of thousands of fossil fueled vehicles. What they can do is offer technology management but so do a bunch of other providers. But then there’s nothing behind the curtain, eh?.

WEST VIRGINIA INCOME TAXES

One of the more interesting proposals to be made in this 2021 budget season comes out of West Virginia. The Governor has proposed eliminating the state’s personal income tax. The debate now underway includes several different plans to make up for the lost revenue the end of the income tax would bring. One idea the governor has is a “tiered” system of severance taxes. The tiered system would tie severance taxes collected by the state on oil, natural gas and coal extraction to current market prices for each commodity.

Each commodity would be taxed at one rate as long as the price remained below a designated level, but would be taxed at increasing rates as the price rises. Previous attempts to change the state’s severance tax scheme proposed that when the price of natural gas was less than $3 per thousand cubic feet, it would be taxed at 5%. As the price of gas rose, the rate would increase correspondingly, maxing out at a 10% rate when prices exceed $9 or more per thousand cubic feet.

The debate occurs in the absence of a formal legislative proposal from the Governor. When a tiered system was included in legislation in 2017, the plan included provisions that when the price of natural gas was less than $3 per thousand cubic feet, it would be taxed at 5%. As the price of gas rose, the rate would increase correspondingly, maxing out at a 10% rate when prices exceed $9 or more per thousand cubic feet.

The proposal comes as states with progressive income tax schemes have had better than expected revenues as those at the top of the scale were better able to keep their jobs and maintain income. The proposal also comes as the reality of low energy prices continues to sink in. In 2017, the state estimated that the revenue impact from a tiered severance tax system would be at best neutral. It expects that current price dynamics will remain for an extended period.

NEW JERSEY BUDGET

Governor Phil Murphy released his budget proposal for FY 2022. It comes after the state extended its fiscal 2021 year end and enacted tax increases. This plan does not add to those increases. The proposed FY2022 budget addresses one of the major drags on the state’s credit by including an additional $1.6 billion to meet the goal of contributing 100 percent of the Actuarially Determined Contribution (ADC) to New Jersey’s pension system a year earlier than initially planned. The proposed $6.4 billion pension payment, which includes contributions from the State lottery, would mark the first time the State has made a full contribution since FY1996. 

The $44.83 billion spending proposal assumes 2.4 percent growth in total revenue and includes a sizable surplus of $2.193 billion, just under five percent of budgeted appropriations. The proposed FY2022 budget increases state aid to schools by $576 million. The State’s Garden State Guarantee, which provides two years of free tuition at four-year institutions for students with household incomes of less than $65,000 is funded in the budget.

The FY2022 budget proposal also increases total resources for NJ TRANSIT to $2.65 billion, nine percent over FY2021 and 15 percent over FY2019. As a result of last year’s millionaires tax enactment, the proposed FY2022 budget includes $319 million in direct tax relief for middle-class families, which will provide up to a $500 rebate to over 760,000 couples and individuals with qualified dependents. The budget also includes $1.25 billion in funding to support various property tax relief programs.

The proposal checks off a significant number of boxes in terms of the state’s historic areas of concern: pensions, NJ Transit, state aid to limit local property taxes; middle class tax rebates, and debt issuance. It’s the surest sign of all that 2021 is an election year in NJ. Nonetheless, if adopted the overall impact on the state’s credit would be positive.

PUERTO RICO DEBT PLAN

Puerto Rico’s Financial Oversight and Management Board (FOMB) announced a new plan support agreement (PSA) with holders of $18.8 billion out of a total $35 billion in general obligation (GO) and Public Buildings Authority (PBA) debt. The new PSA reduces the approximately $18.8 billion of GO and GO-guaranteed liabilities by 61 percent, to $7.4 billion, resulting in an extra $2.7 billion in a principal debt cut compared to the agreement reached in February 2020. The deal reduces GO debt service payments by $4.7 billion, as well as cutting the maximum annual debt service by 22%, to $1.15 billion, relative to last year’s PSA.

The deal includes a contingent value instrument (CVI) that pays an additional amount to bondholders if Puerto Rico’s economy outperforms the projections in the FOMB-certified May 2020 commonwealth fiscal plan. The CVI relies on collections of 5.5% of the commonwealth’s 11.5% sales and use tax (SUT) pledged to Cofina that exceed estimates. The creditors who are a party to the agreement would receive 45% of the increment above the amount projected, subject to annual and lifetime caps. GO and PBA bondholders would receive $7.4 billion in new bonds and $7 billion in cash. 

The agreement will be presented as part of the plan of adjustment (POA) the fiscal panel is due to file in court by the March 8. The new agreement’s cash and debt consideration to bondholders provides a 27% average reduction for GO bondholders and a 21% average reduction for PBA bondholders. The chairman of the FOMB said the GO and PBA deal now has the support of 60% of bondholders. Court approval the deal must be submitted to a vote in which two-thirds of participating bondholders vote in favor in each class of bonds. 

In a nod to the populist pressures facing the Governor, he said would not support a plan that includes an agreement between the Official Retirees Committee and the oversight board for an 8.5 percent cut to government pensions exceeding $1,500 a month, which would affect 25% of retired public workers. It sets up as another example of pensioners being favored over bondholders as was the case with the City of Detroit bankruptcy.

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.