Joseph Krist

Publisher

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It has become increasingly clear that the poisoned current political environment is claiming meaningful aid to state and local government as its primary scalp. It is clear that state and local government face untenable choices in the absence of significant help. The debate comes even in the face of clear indications that significant layoffs will occur in October and after without another PPP round. Furloughs will shift to layoff. The airlines are only the most visible example but many industries will be impacted as increasing pressure on disposable income holds down spending and delays recalls to all types of businesses.

The implications for municipal bonds are increasingly negative as federal inaction not only chokes off revenue but does it at a time when expenses cannot be similarly adjusted. It makes no sense, especially when states are being left on their own from not just a fiscal standpoint but also a regulatory/legal standpoint. If Congress and the President want to abdicate their responsibilities, they could at least provide some resources to those who are actually managing the pandemic.

Inaction also hamstrings efforts at economic stimulation. Increasingly, states and their agencies are announcing delays and postponements of significant infrastructure projects which could be a good source of virtually immediate economic activity. Longer term, delays in several large projects have significant economic implications which will extend the time of recovery and act as a cap on economic upside. If you can put aside the politics for just a minute, the illogic of the current state of affairs is clear.

There is only one partner in the debate which can print money and legally run a deficit – the federal government. That, along with requirements that every state except Vermont must operate under a balanced budget means that the federal government occupies a unique and pivotal position in the process of recovery. That recovery should not count on the results of the upcoming election. There are clear solutions, it’s the politics holding things up.

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WHY PANDEMIC AID IS COMPLICATED

Congress returns 22 days before the start of the federal fiscal year and there appears to be declining hope for a significant federal bailout package. There remains a significant segment of Senate republicans seemingly dead set against any additional aid to state and local government. While much of the opposition seems to be based in an antipathy towards “blue” states, we look at one “red” state to see why there might be a basis for opposition.

In 2016, the Utah legislature authorized the creation of the Utah Inland Port. The plan was to provide fun ding for infrastructure which would connect Utah industries – energy primary among them – with overseas buyers of exports from the Beehive State. In response, private interests undertook a variety of investments. The most prominent is the development of a cargo facility for exports of Utah coal in the Port of Oakland, CA.

The 2016 legislation was designed to create a $53 million fund to support the development of “throughput infrastructure” out of state. The Oakland port facility is the most prominent example. Efforts to develop such a facility have been the subject of ongoing litigation. That process has stymied development and the developer has subsequently filed for bankruptcy.

Now in the midst of the pandemic and the economic pressure being felt by all levels of government, four Utah counties are looking for $20 million of the $53 million of funds to be transferred to the port developer. Carbon, Emery, Sevier and Sanpete counties have told the bankruptcy court overseeing the developer’s Ch. 11 filing that “this project will not only save high-paying jobs but will promote economic growth in rural Utah and create new and lasting jobs for the state and region.”

It is easy to question how to balance the realities of economic development with the fiscal realities of the pandemic. There have been many references like those targeting pension funding needs and unions. What there has not been is as much criticism of subsidies and tax “incentives” which reduce revenues available to government. Whether it is a subsidy for a dying industry (coal) or for a foreign company like Foxconn, these already controversial programs undermine the case supporting them.

We are seeing numerous efforts across jurisdictions to use the pandemic as either cover for or an excuse for significant regulatory concessions or subsidies for business. The need to rebuild the economy is forcing governments to consider these programs even as they experience significant revenue losses. They come under increasing scrutiny in the wake of the failure to extend programs like the PPP and the failure to enact additional aid to local governments. They allow opponents of more aid to point to programs like the Utah program (which serves an out of state entity) to support their opposition.

CANNABIS IN THE KEYSTONE STATE

Pennsylvania is one of the states which chose to enact what was effectively an interim budget in order to start the fiscal year beginning July 1. The commonwealth passed a $25.8 billion interim fiscal 2021 budget in May that funds the state through the end of November. With the course of the pandemic uncertain and the outlook for federal stimulus uncertain at best, states and cities will have to constantly update and revise their plans for balancing budgets in the current fiscal year. The pandemic and its economic effects have put heretofore unpopular ideas for raising revenues back under consideration.

The Governor of Pennsylvania has proposed legalization of adult-use cannabis to help with the commonwealth’s recovery from COVID-19. The proposal reflects The State Auditor  estimates that regulating and taxing marijuana for adult use could generate nearly $600 million of new revenue annually. The Governor’s plan cites significant revenue generations in states like Washington and Colorado in support of legalization. The proposal would direct a portion of the revenue toward existing small business grants. Half of the grants would go to historically disadvantaged businesses with the remainder going to social justice programs.

The debate comes as the Commonwealth examines the future of its state liquor monopoly. The debate has been contentious and it can be expected that the debate over the Governor’s proposal will be vigorous in the socially conservative state. To reflect this reality, the Governor wants to implement legalization incrementally. His initial ask is for decriminalizing possession of small amounts of marijuana. It comes as New Jersey voters will consider the full legalization of cannabis in November and efforts to do the same in the New York legislature are expected to be renewed as the impact of the pandemic fades.

AIRPORT REVENUES

In 1982, a federal law was enacted that imposed constraints on the use of airport revenue (e.g., concessions, parking fees, and airlines’ landing fees), prohibiting “diversion” for non-airport purposes in order to ensure use on airport investment and improvement. However, the law exempted “grandfathered” airport sponsors— those with state or local laws providing for such diversion—from this prohibition. The FAA Reauthorization Act of 2018 provides for GAO to examine grandfathered airport revenue diversion. The study was designed to provide information for those considering a repeal of those provisions.

A repeal of grandfathered revenue diversion would have complex legal and financial implications for transportation authorities. Transportation authority officials said that a repeal would inherently reduce their flexibility to use revenues across their assets and could lead to a default of their outstanding bonds if airport revenues could no longer be used to service debt; exempting outstanding bonds could alleviate some financial concerns. For city and state government sponsors, a loss in general fund revenue could result in reduced government services, though they said a phased-in repeal could help in planning for lost revenue.

Where would repeal have its primary impact? From fiscal years 1995 through 2018, FAA data show that the nine grandfathered airport sponsors lawfully diverted revenue amounts that varied from as little as no diversion by some sponsors in some years to as much as $840 million by a sponsor in one year. All city- and state-government airport sponsors regularly diverted revenue for each of the 24 years from 1995 through 2018, per their local laws and agreements. In 2018, revenue diversions for the five airport sponsors ranged from almost $7 million (City of St. Louis) to about $47 million (City and County of San Francisco). diverted airport revenue comprised less than 1.5 percent of the airport sponsors’ total annual general fund expenditures in 2018 and less than 4.5 percent of their airport(s) operating revenues for that year.

Who would be hurt by a repeal?  Maryland officials explained that under a repeal, the Maryland state legislature would need to restructure MAA to separate its revenues from the state transportation trust fund. Since MAA does not currently have the legal authority to maintain its own cash reserves to finance its own infrastructure investments, officials said a repeal would necessitate legislation establishing a separate state aviation fund for MAA, with a one-time cost of at least $250 million needed to provide the fund with its own starting balance.

In Massachusetts, if Massport were no longer able to use airport revenue to help support its seaport, costs to seaport users would increase, resulting in negative regional economic effects, including job losses at the port and in the wider community. Officials also said that repeal would prohibit Massport’s payments to three neighboring cities, which would hinder cooperation with those cities on airport infrastructure expansion.

The Port Authority of New York and New Jersey is unique among the impacted agencies in that it is the only one serving more than one state. For the Port, a repeal would include possible non-compliance with its governing statutes and breach of its contractual covenants with its bondholders. The general reserve fund statute requires that surplus revenues from PANYNJ’s assets be pooled and does not indicate how PANYNJ should proceed if it were required to stop consolidating revenue.

All of the transportation agencies indicated that a repeal could result in airport revenues no longer being permissible to secure or pay debt service on consolidated bonds. According to Massport and PANYNJ officials, a repeal would cause their agency’s outstanding bonds to be in default or subject their agency to a legal cause of action for breach of contract. According to Massport and PANYNJ officials, a repeal would cause their agency’s outstanding bonds to be in default or subject their agency to a legal cause of action for breach of contract. These airport sponsors currently have $1.6 billion and $22 billion in outstanding bonds, respectively.

TOBACCO

The 2020 National Youth Tobacco Survey has been released. The annual review gives a good indication of current trends among the tobacco industry’s prime marketing target. In 2020, 19.6% of high school students (3.02 million) and 4.7% of middle school students (550,000) reported current e-cigarette use. Among current e-cigarette users, 38.9% of high school students and 20.0% of middle school students reported using e-cigarettes on 20 or more of the past 30 days; 22.5% of high school users and 9.4% of middle school users reported daily use. Among all current e-cigarette users, 82.9% used flavored e-cigarettes, including 84.7% of high school users (2.53 million) and 73.9% of middle school users (400,000).

The significance for a tobacco investor is that in spite of sustained demand for nicotine among a prime market cohort, the demand is for e cigarettes rather than “sticks”. It’s actual cigarette sales of cigarettes that matter to bondholders. The 20% use rate for e cigarettes makes the case for declining cigarette consumption.  The most recent Federal Trade Commission Cigarette Report was released at year end. It showed that the number of cigarettes that the largest cigarette companies in the United States sold to wholesalers and retailers nationwide declined from 229.1 billion in 2017 to 216.9 billion in 2018. That represents a decline of over 5%.

PANDEMIC CASUALTIES – RATINGS

As the pandemic continues, the expected impact on ratings is finally emerging. This week, S&P offered examples. S&P Global Ratings lowered its long-term rating by two notches to ‘BBB’ from ‘A-‘ on YMCA of Greater New York’s (YMCA) and Build NYC Resource Corp.’s general obligation (GO) bonds, issued for the YMCA. The outlook is negative. Gyms were not allowed to open until mid-August in New York State. The Y is planning on opening nine of its 22 branches in September 2020. Capacity is limited to 33%. The organization is facing a projected general operating deficit of $14 million in calendar year 2020.

S&P Global Ratings lowered its long-term rating and underlying rating (SPUR) on the New Orleans Aviation Board’s (NOAB) general airport revenue bonds (GARBs), issued for Louis Armstrong New Orleans International Airport (MSY), to ‘A-‘ from ‘A’ and the outlook remains negative. The announcement cited “the severe drop in demand has diminished NOAB’s overall credit quality and will likely pressure financial metrics relative to historical levels.

We view this precipitous decline not as a temporary disruption with a relatively rapid recovery, but as a backdrop for what we believe will be a period of sluggish air travel demand that could extend beyond our rating outlook horizon.” S&P also lowered its rating to ‘A-‘ from ‘A’ on St. Louis’ airport revenue bonds issued for St. Louis Lambert International Airport (STL) and kept that rating on negative outlook as well.

Private student housing remains vulnerable especially in light of the initial poor experience with efforts to return students to campus at so many schools. S&P Global Ratings cut by two notches to BB from BBB-minus the 2017 student housing revenue bond issue sold through the Illinois Finance Authority on behalf of the not-for-profit CHF Chicago LLC. The facility opened last Fall  more than 97% occupancy rates in fall 2019 and spring 2020. As of Aug. 24 a 53% occupancy rate set it up for significantly weaker financial performance.

Private universities with pressured finances continue to find themselves in a ratings vice. Enrollment declines are hurting revenues while online learning keeps students away along with the auxiliary revenues they would generate living on campus. The latest example is John Carroll University, a Catholic Jesuit private university located in University Heights, Ohio. Its rating outlook was shifted to negative by Moody’s. The school is showing how smaller private universities are trying to cope. The school plans expense reductions in fiscal 2021 to mitigate losses in net tuition and auxiliary revenue, in addition to utilizing remaining CARES Act funds and has approved a supplemental endowment draw in fiscal 2021 to help manage the revenue losses.

SUPPORT GROWS FOR STRINGS ON NYC BORROWING

We are glad to see support growing among respected outside observers for some controls on being imposed on New York City’s fiscal position be part of any borrowing Authority granted by the State to help the City manage the pandemic. The latest example is the private watchdog,  the Citizens Budget Commission, which has been a serious observer of New York City’s fiscal position for nearly 80 years. The control board position is that the State “should certify borrowing as part of a “comprehensive and feasible” multiyear plan that leads to fiscal stability.

It supports a period during which the control board must approve and condition each borrowing instance, monitor the city’s fiscal management, and approve or reject city actions with major fiscal impacts. A control period would continue until the board determines the city can support recurring spending with recurring revenues or the city meets pre-determined benchmarks.”

It really is not unreasonable to attach extraordinary terms to efforts to deal with this extraordinary situation. The market – investors, traders, raters – are all in a position to support and facilitate well reasoned and structured financing plans to deal with these most extraordinary fiscal times. The message should be clear to the Mayor that he needs to come to the table with a responsible plan that reflects a willingness to accept input from the whole range of sources. The key to resolution of the 1970’s fiscal disaster that was NYC was the involvement of both the private sector and the unions in formulating an overall plan. That sort of engagement seems to be something the Mayor believes he can shun. If he keeps it up, he may wind up having to borrow for one year at a higher cost than from the Fed.

In the meantime, a bit of kabuki theater is taking shape in terms of the government/business relationship. Earlier in the summer, the Partnership for New York made clear its view that the private sector is best suited to solving the city’s multiple economic problems. Then a predictable spate of responses generally rejecting such an approach occurred. The Partnership then undertook a study which unsurprisingly reinforced the private sector bias. Now a group of chief executives from some 150 of the city’s major businesses have issued a letter decrying the current state of affairs in NYC and asking the Mayor to follow the Partnership’s framework. All of this while the Mayor plays chicken with the Legislature over layoffs. Different circumstances have driven us down this road before.

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