Joseph Krist

Publisher

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PUBLIC BANKS

California legalized public banks last October. Now the first steps in establishing local public banks have been taken. The Santa Cruz County Board of Supervisors voted to begin discussions with  jurisdictions proposing a viability study, the first step in the creation of a public bank. A letter was sent to Monterey, Santa Clara, San Luis Obispo, San Benito and Santa Barbara counties and to the cities of Seaside, Monterey, San Luis Obispo, Watsonville, Scotts Valley, Santa Cruz and Capitola.

The move has achieved significant support not only from progressive legislators but a broader slice of the political establishment. The effort to coordinate with a significant number of jurisdictions reflects Santa Cruz County’s view that “the scale of operations for public banks is far too large to be undertaken by anything smaller than the largest cities or counties in California or multi-jurisdictional efforts.”  The idea of a public bank has even received support from the business community. The Monterey Peninsula Chamber of Commerce and the Salinas Taxpayers Association have said “this is a progressive vision that would have some crossover appeal for business.”

RURAL INTERESTS TAKE ANOTHER HIT

The U.S. Department of Education recently dealt another blow to some of the nation’s poorest rural school districts when it informed them of a bookkeeping change which will likely result in a significant reduction in federal aid to local school districts. 800 schools stand to lose thousands of dollars from the Rural and Low-Income School Program because the department has abruptly changed how districts are to report how many of their students live in poverty. 

The department has allowed schools to use the percentage of students who qualify for federally subsidized free and reduced-price meals, a common proxy for school poverty rates, because census data can miss residents in rural areas. This has been the case since the program began in 2002. Now the Department insists that the Districts use data from the Census Bureau’s Small Area Income and Poverty Estimates to determine whether 20% of their area’s school-age children live below the poverty line.

Congress created the Rural Education Achievement Program when it determined that rural schools lacked the resources to compete with their urban and suburban counterparts for competitive grants. The program is the only dedicated federal funding stream for rural school districts. There is some geographic concentration among the impacted school districts. Over half of them are in Oklahoma.

Some 100 of the 149 schools in Maine that qualified last year would lose funding this year under the census criteria. The funding supports increased literacy and is also often applied to fund technology investments in areas which are already plagued by limited or no broadband access. Rural school districts serve nearly one in seven public-school students and the Rural School and Community Trust found that many districts “face nothing less than an emergency.” Nearly one in six students living in rural areas lives below the poverty line, one in seven qualifies for special education services, and one in nine has changed residence in the previous 12 months.

SUMNER NUCLEAR DEBACLE CONTINUES

The South Carolina legislature is in the middle of a debate over the future of the South Carolina Public Service Authority (Santee Cooper). The debate is over whether to maintain the status quo or to sell the utility which finds itself mired in the center of the cancelled  V.C. Sumner nuclear plant quagmire. The V.C. Summer project cost more than $9 billion before it was called off in 2017 by its sponsor, South Carolina Electric and Gas.  Now that the state looks to move forward in its process of deciding what to do, the story has taken yet another turn.

The Securities and Exchange Commission and the U.S. Attorney’s Office for South Carolina have announced that they are suing executives of SCE&G for fraud in their disclosures (or lack thereof) in connection with the failed project. The SEC’s lawsuit was filed against SCANA (the holding company for SCE&G) and Dominion’s (the buyer of SCE&G) electricity business in South Carolina, as well as two of SCANA’s top executives during the project: former CEO Kevin Marsh and former Executive Vice President Steve Byrne.

Bechtel Corp., one of the world’s largest construction and engineering firms was paid $1 million to study the project by SCANA and Santee Cooper, which owned 45% of the reactors. Bechtel informed SCANA’s executives in 2017 that the project likely wouldn’t be completed in time to claim billions of dollars in federal tax credits that were set to expire in 2021. Gov. Henry McMaster forced Santee Cooper to release the study.

While nuclear power is often mentioned as a potential source of source of climate friendly generation, the fact is that the economics of nuclear generation construction remain prohibitive. The financial risks associated with nuclear power have yet to be successfully addressed and the industry finds itself in much the same place as it was in the 70’s and 80’s when it came close to bankrupting numerous investor owned utilities. Many of the joint action agencies around the country were established essentially as bailouts for the investor owned sponsors of nuclear power. The South Carolina Public Service Authority is just another in a long line of such entities.

This is what happens when factors other than economics are allowed to drive decisions. The fact that this project as well as the Votgle projects in Georgia have failed is not a surprise. The decision to participate was driven by politics as much as anything else. When project sponsors as well as potential investors ignore economics and reality, it is at their peril.

JEA RATINGS

Moody’s has decided to weigh in on the City of Jacksonville’s efforts to extricate itself from the aforementioned financial disaster that is the Plant Votgle expansion. The city and its utility were the subject of downgrades this week as Moody’s views the action as ” calling into question its willingness to support an absolute and unconditional obligation of its largest municipal enterprise, which weakens the city’s creditworthiness on all of its debt. The city and JEA sued to invalidate a contract the city-owned utility signed in 2008 with a Georgia utility authority that binds JEA to help pay open-ended construction costs at the Votgle expansion.

Moody’s made it clear that the rating would be restored if the City dropped the suit. A recent estimate for the project’s completed costs was around $27 billion. JEA could pay $2.5 billion or more of the project’s cost. The plant was once priced around $14 billion.

Given the unique nature of nuclear plant construction and its financing, it is hard to make the case that Jacksonville is somehow unwilling to meet its overall debt obligations. The governance issues which the action has raised in conjunction with the botched effort to privatize the Jacksonville Electric Authority are legitimate but there has never been an implication that Jacksonville is seeking to walk away from its debts. We are more troubled by the attempt to privatize the utility because of the governance and oversight issues it raised.

From our standpoint, Moody’s is doing the right thing for the wrong reasons. The privatization effort revealed weak oversight. The legal challenge to the power purchase agreement with MEAG to purchase Votgle capacity is a legitimate process to address the issues arising from the Plant Votgle debacle. We do not agree that this is a sign of an overall policy change impacting the City’s willingness and ability to pay its debts.

HARDER TIMES FOR COAL COUNTRY

The US Federal Trade Commission released a February decision to block a joint venture in the Powder River Basin (PRB) coal-producing region of Wyoming. Peabody and Arch in June 2019 had announced a definitive agreement to combine seven operating coal mines and reserves in the PRB and Colorado into a joint venture. The expected synergies were being undertaken to improve profitability in the face of a coal market under continuing pressure from the decline in demand from utility operators. The US Energy Information Administration forecasts that production in the US Western Region, including the PRB, will fall to 310 million tons in 2020, down from 378 million tons in 2019 and 418 million tons in 2018 – a decline of over 25% in two years.

Much has been made of the potential economic impact of responses to climate change and their dampening impact on coal prices. The decline of demand from utilities especially impacts the PBR as its surface mined low sulfur coal is especially attractive to utilities. Moody’s projects that US coal production will fall by 15%-20% in 2020, based on significant ongoing reductions in the electric utility sector’s coal consumption, down from 24% in 2019 and about 50% in 2008. Like so many other industries where climate and economic realities have led to long term declines in production, the handwriting has been on the wall for some time in communities whose economies have been built around coal. The impact of climate change on demand is yet one more brick on the load of the coal industry.

The region in northeastern Wyoming which comprises the Powder River Basin covers all or part of 8 counties in the state. Coal operations are largely conducted within two – Campbell and Converse counties. There is not a lot of tax backed debt outstanding and the bulk of it is for school districts. The major city in the region – Gillette – is a Aa3 rated issuer but its dependence upon the coal based economy has a dampening impact on the city’s rating potential.

The fact that credits are subject to single industry dependence for economic, demographic, and tax growth is not new even though some seem to believe that climate change related pressures are somehow different in terms of their potential credit impact. The changes coming to credits like those in the powder River Basin are nothing that market participants haven’t seen before.

CHINA SYNDROME HITS U.S.PORTS

First it was tariffs. Then it was the Lunar New Year. The corona virus followed up. It’s a triple threat impacting port operations throughout the country. Now we have data to support those concerns.

On the West Coast, The Port of Los Angeles saw the number of 20-foot equivalent units fall 5.4% in January when compared with 2019. The port processed 806,144 TEUs compared with 852,449 a year ago. Port of Long Beach saw a 4.6% year-over-year drop in January. The port processed 626,829 TEUs compared with 657,286 in 2019. The Port of Oakland experienced a 0.6% in January, processing 211,160 TEUs compared with 212,433 in 2019. The Northwest Seaport Alliance, which operates facilities in Seattle and Tacoma, Wash., saw a 19.1% year-over-year drop in TEUs as it processed 263,816 containers compared with a record 326,228 last January. 

While the largest numbers of ill patients is found along the West Coast, the impact is being felt at East Coast ports as well. The Port of Savannah saw a 12.7% decline in January volume as the port processed 377,672 TEUs compared with 433,079 in 2019. The Port of Virginia saw a 5.3% decline in January, to 227,234 TEUs from 240,111 in 2019. The Port of New York and New Jersey, saw its monthly container volume slip in January by 0.9%, to 617,024 TEUs compared with 622,531 during the year-ago period.

CORONA VIRUS

The concerns which might arise as the result of the corona virus breakout are not hard to guess at. Credits dependant on travel (airports, transit) are obvious candidates. Many convention centers and conference centers will see cancellations. Hotel credits are obviously at risk. These could obviously experience short term credit deterioration. In our view, the issue is not necessarily short term risk of default but the longer term impacts of events like the pandemic.

After 9/11 travel limitations caused many businesses to rethink their conference and meeting practices. Conference lengths were shortened. Many were moved to in house sites. Declines in occupancies and demand were experienced. The underlying assumptions driving feasibility studies no longer were no longer valid. SARS had a similar impact on hotels, travel, and tourism in 2003. The financial crisis of 2008 also had similar impacts. This caused a rethink of the importance of many of the meetings and conferences and increased the utilization of online meetings and presentations.

Now that mass meetings of all sorts are being discouraged and cancelled, the potential for disruption both short and long term grows. It is important for investors in this space to understand the project specific credit drivers supporting the projects you own. Know whether the credits in this space you own are stand alone project financings or whether they rely on supplemental government support. Make sure you understand the nature of the local obligation which you are relying on. The level of government commitment varies widely and often is contingent on future legislative actions.

RAINY DAY FUNDS WHEN IT ISN’T RAINING

A recurring theme in the municipal bond press has been that states are well positioned to deal with any potential recession because they have been able to accumulate reserves to fund initial revenue shortfalls. That is all well and good when times are fairly normal. Unfortunately, that might not remain the case. Huge reserves do position states well but only if they are used for the purposes for which they are intended. We are beginning to see signs that the relative health of state general fund balances or “rainy day funds” may be pressured as legislators look to fund needed infrastructure and now public health needs.

There is no way to assess right now the impact on state budgets which might result from the corona virus. There is such inconsistent information and resources coming from the federal government that states will have to share the initial burden. The potential for serious financial consequences remains. The crisis comes at a time when skepticism is arising about various proposals to increase funding at the state level for  shifted attentions to issues infrastructure. Connecticut legislators have expressed a desire to apply some of the state’s budget reserves to funding transportation in lieu of higher gas taxes or tolls.

In Michigan, Republicans are proposing replacing the six percent sales tax on gas with a per-gallon tax. The goal is try to gain the money without raising net taxes on Michiganders. The plan is estimated to generate $800 million which would then be directed toward local and county-maintained roads. Some 92% of the roads in the state are owned and maintained by cities, villages and county road commissions. This plan is a response to the Governor’s proposal to issue $3.5 billion in debt for transportation. That proposal followed a rejection of a proposed increase in gas taxes.

EARTHQUAKE RISKS

It has been a while since the San Francisco and Northridge earthquakes brought attention to the risks of those sorts of events. Since then, climate change and its attendant impacts on life in the State have shifted attention to events like wildfires and issues with water. The fear has skewed more towards the potential impacts of those events and the potential impact from seismic events have received less attention.

So our radar was awakened by the release of a study by the Earthquake Engineering Research Institute San Diego Chapter. A study, partially funded by FEMA, found that San Diego County is subject to seismic hazards coming from several regionally active faults, including the local Rose Canyon Fault which runs through the heart of downtown San Diego. An earthquake originated on this fault may produce substantial damage and losses for the San Diego community. San Diegans need to be aware of this hazard.

According to the study, The Rose Canyon Fault Zone strikes through the heart of the San Diego metropolitan area, presenting a major seismic hazard to the San Diego region, one of the fastest growing population centers in California and home to over 3.3 million residents. The region’s large population coupled with the poor seismic resistance of its older buildings and infrastructure systems, make San Diego vulnerable to earthquakes. Best models show San Diego County facing an 18 % probability of a magnitude 6.7 or larger earthquake occurring in the next 30-year period on a fault either within the County or just offshore. Primary geologic hazards include surface fault rupture and severe ground shaking from La Jolla, along the I-5 corridor, through Old Town, the Airport, downtown San Diego, and splintering into the San Diego Bay, Coronado, and the Silver Strand.

The scenario earthquake the study observed  is expected to cause widespread damage to buildings, including moderate to severe damage to approximately 120,000 of the nearly 700,000 structures countywide. Economic losses associated with building and infrastructure damage are estimated at more than $38 billion. In part, that reflects the fact that much of the existing infrastructure of the San Diego region was built before recognition of the seismic hazards posed by the Rose Canyon Fault Reason to disinvest? No. But San Diego is usually not associated with earthquake risk to the same extent L.A., S.F. and many inland communities are. It’s just another factor in the credit equation to evaluate. 

NYU LANGONE UNDER FEDERAL INVESTIGATION

NYU Langone Medical Center is a major provider in Manhattan and regionally in the New York metropolitan area. It has revealed that it received a subpoena in January from HHS’ Office of the Inspector General that asked for information related to its Medicare cost reports submitted from 2010 to 2019. The Office of the Inspector General is asking for data and documents used to calculate how much money the health system should receive for indirect medical education expenses. The indirect portion is a welcome source of revenue for teaching hospitals that train physicians and tend to have higher costs.

NYU Langone closed on a $466 million bond issue on January, 2020. There is reference to how much the hospital gets from indirect medical education expenses but the offering document does not reference the subpoena. The time period in question was very difficult for NYU Langone. Over that time, it opened a new facility and suffered significant damage from Superstorm Sandy. The investigation does not appear as a pre-sale rating concern.

It’s not clear as to what amount of money may be at risk or the timing of a finding, if any. It is also fair to note that this process often leads to negotiated resolutions. It is unlikely that the federal government would be seeking to significantly damage the hospital’s financial position. It is however, something to watch.

HARVEY, IL BOND RESTRUCTURING

The Chicagoland suburb of Harvey has been in litigation with a variety of parties as it seeks to regain its financial footing after years of declining property values and revenues. The weak finances have landed the city in hot water with its uniformed services pensioners, the City of Chicago, and its bond insurers. Holders of a 2007 issue of general obligation  bonds have been in litigation since the city defaulted on that debt ($32 million).

After a status hearing last week in a lawsuit filed by holders of Harvey’s $32 million 2007 general obligation bond issue, Harvey’s legal representative hinted that a bond exchange might be the city’s best alternative. Under the terms of a decision rendered by the court in December, 2019, Cook County was ordered to segregate Harvey’s tax revenues needed to cover debt service payments in an escrow before sending tax dollars to the city. Harvey’s interim agreement with the 2007 holders that frees up $301,000 of property tax revenue currently held in escrow was approved in Cook County court.

Chicago sued Harvey after it fell in behind 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. A new administration in Harvey has argued the receivership has failed to accomplish the goal of bringing the city current  on water payments while extracting fees for its services and withholding revenues. The bondholders argue they are entitled to a portion of water rents and rates because about $5 million of the 2007 bonds financed water system improvements. 

Ultimately, a negotiated restructuring is likely the city’s best plan for resolving its debt dilemma. Any such resolution would likely extend the maturity of the debt and reduce debt servicing obligations significantly in the next few fiscal years.   

CALIFORNIA ELECTIONS HAVE NATIONAL IMPLICATIONS

Californians voted on some 289 local ballot measures. While they are local, some reflect policies which are being considered nationwide. Proposition D targets San Francisco’s rampant storefront vacancy problem with a tax on landlords who keep stores empty for more than six months. It would impose a $250 per foot tax on sidewalk frontage the first year, then $500 and $1,000 in subsequent years. As we go to press, it received the required 66% approval pending mail-in ballots. New York’s City Council is considering legislation along the same general lines.

There were mixed results for issues funding public transit and schools. In many places the issue was not whether there was a majority in favor of proposals but whether the required supermajorities (they range from 55 to 66.7%). Housing and development issues were front and center. Prop. E is San Francisco would tie commercial development to residential development. It is a reaction to the current real estate/housing environment and looks like it will pass with the required supermajority.

These are all issues which resonate nationally. Look and learn to see where politics and policies are going. A growing constituency across the country is more willing to embrace government intervention in local housing markets and developments. California is just the leading indicator.

WILDFIRE RATINGS FALLOUT

Recent actions taken to lower ratings in the aftermath of the most recent wildfires in California are impacting some of the state’s largest and best known electric utility issuers. while PG&E has been at the center of most of the attention paid to the role of utilities in the spread of wildfires, municipal utilities are not immune to the impact. recently, S&P downgraded the long-term and underlying ratings on the Los Angeles Department of Water & Power (LADWP) power system revenue bonds to ‘AA-‘ with a negative outlook from ‘AA’.

S&P specifically cited its updated assessment of the department’s overall wildfire risk profile as informed by our review of its revised wildfire mitigation plan taken in conjunction with the department’s specific wildfire exposure and ongoing potential liability claims as measured against power system reserves and insurance coverage. is a The risk posed by the operation of large scale transmission and distribution infrastructure is yet another headwind facing the utility as it navigates an increasingly complex array of issues facing LADWP as it operates in the California legislative and regulatory environment.

The downgrade of one of the major electric utility credits in the state has had knock on effects on the ratings of joint action projects in which LADWP is a significant participant. The latest example is the S&P Global Ratings revision of the outlook to negative from stable and affirmed its ‘AA-‘ long-term rating on the Southern California Public Power Authority’s (SCPPA) series 2012A and 2012B Mead-Adelanto Project revenue bonds and Mead-Phoenix Project revenue bonds.

The action reflected the significant share of project entitlement and debt service represented by participants rated AA-/Negative. LADWP and Glendale together represent a significant share of transmission entitlement and debt service. It comes as LADWP deals with the conversion of the Intermountain generating asset away from coal and the aggressive climate change mitigation targets legislated by the State.

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.