Smith's Research & Gradings
The Change Agent
Mr. Blake has a 30-year career in municipal financial analysis that began with structuring bank credit and liquidity facilities for muni clients. He started at Moody's in 1998 and experienced steady advancement to become a senior analyst of state credits. In 2006, Mr. Blake joined Goldman Sachs as a municipal credit specialist. But, in 2011, Mr. Blake was lured back to working at Moody's to undertake the real mission impossible in municipal credit analysis: changing the ratings methodology.
The Change Agent
Among other responsibilities, Mr. Blake returned to head up a special team tasked with incorporating public pension obligations more consistently into the credit assessment of America's states and local governments. He dared to shine the bright lights of rigorous credit analysis into the deep dark recesses of municipal finance – public pensions.
Mr. Blake is quick to give accolades to Gail Sussman for identifying the growing cost of funding public sector pensions as a systemic credit risk. She tasked Mr. Blake with helping lead the process from inception to implementation. And, Moody's tapped Mr. Aaron to provide the actuarial expertise required to make Moody's public pension risk analysis relevant to the municipal bond investment process.
In July 2012, Mr. Blake rolled out the proposed changes when Moody's requested comments on modifications to the way pension data was incorporated into its analysis.
Spiotto Testimony Excerpt at the House Hearing on Puerto Rico
On Wednesday , July 25 , 2018 , at 2:00 p .m., in Room 1324 Longworth House Office Building, the House Committee on Natural Resources held a Full Committee oversight hearing titled "Management Crisis at the Puerto Rico Electric Power Authority and Implications for Recovery."
The following is excerpted from the written testimony of James E. Spiotto before the House Committee on Natural Resources regarding Management Crisis at the Puerto Rico Power Authority and Implications for Recovery. Mr. Spiotto, as of January 1, 2014, retired as a Partner of Chapman and Cutler LLP. He is a Managing Director of Chapman Strategic Advisors, LLC, a consultancy providing educational and strategic insights to market participants concerning finance topics of interest. The statements expressed in the written material are solely those of the author and do not reflect the position, views or opinions of Chapman and Cutler LLP or Chapman Strategic Advisors LLC.
Chairman Bishop, Ranking Member Grijalva and distinguished Members of the Committee, I am honored to address you at its oversight hearing regarding the electrical utility for Puerto Rico, the Puerto Rico Power Authority ("PREPA"). The following remarks are based on my experience in workouts and restructurings of corporate and municipal debt obligations, specifically restructuring and bankruptcy involving electric utilities including the Washington Public Power Supply System, Pacific Gas & Electric, El Paso Electric, Tucson Electric, as well as my prior written testimony to House and Senate Committees on Municipal Bankruptcy and the government finance market including with respect to Puerto Rico in 2015 and 2016.
Canaries in the Coal Mine
– U.S. Regional Banks and Trade Protectionism
Drive through almost any medium-sized town in the United States and you are likely to find a bank. They are often older and solid-looking buildings, meant to convey a sense of security and function as an anchor for the community, be it in Marysville, Kansas or Simsbury, Connecticut. Although the shape of banks has changed they remain central to local and regional economies. In times of economic change, they can function as canaries in a coal mine, warning of something dangerous.
The U.S. economy, helped by a late-cycle tax cut, has become more robust as reflected by solid corporate earnings, low unemployment (around 4.0%), labor shortages in some sectors, and strength in manufacturing and technological production. U.S. real GDP growth appears on track for 2.8% expansion in 2018.
One potential spoiler to the U.S. economic expansion, however, is the burst of trade protectionism that is shaking world markets. Throughout 2018, the White House has wielded the tariff weapon in an effort to strike better deals with all of its major trade partners. This has put into motion tariffs on washing machines, steel and aluminum, with an extensive list of other items looming, as well as counter-tariffs by U.S. trade partners. While company order books are full, earnings are up and skilled workers in demand, there are concerns about rising input costs (both domestic and imported) and the loss of business in overseas markets, a major concern for states, like Texas (which exported $264.5 billion in 2017), Illinois ($65.2 billion), Tennessee ($33.2 billion), California ($172 billion), and Washington ($76.4 billion).
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In the U.S. Senate, Bob Corker (R-TN) and Mark Warner (D-VA) are currently working on a draft bill entitled, the "Secondary Mortgage Market Reform and Taxpayer Protection Act of 2013," copies of which began circulating on June 6, 2013. The bill contemplates winding down Fannie Mae and Freddie Mac and replacing them with a new government agency called the Federal Mortgage Insurance Company (FMIC).
In the U.S. House of Representatives, three years after the Dodd-Frank Act failed to address the need for housing finance reform and end the record taxpayer-funded bailout of Fannie Mae and Freddie Mac, the Financial Services Committee – under the leadership of Chairman Jeb Hensarling (R-TX) – last week approved legislation to end their bailout and create a sustainable housing finance system for America.
According to a recent report by Standard & Poor's Private housing index, home prices dropped by record amount nationwide in May.
The Standard & Poor's/Case-Shiller 20-city index dropped by 15.8 percent in May compared with a year ago, a record decline since its inception in 2000. The 10-city index plunged 16.9 percent, its biggest decline in its 21-year history.
No city in the Case-Shiller 20-city index saw price gains in May, the second straight month that's happened. The monthly indices have not recorded an overall home price increase in any month since August 2006.
Home values have fallen 18.4 percent since the 20-city index's peak in July 2006.
Credit analysts have grown increasingly pessimistic regarding not-for-profit hospitals, according to the Centers for Medicare & Medicaid Services (CMS). Formerly operating under the name, Health Care Financing Administration (HCFA), Tom Scully, the new CMS Administrator of the Office of Research, Development & Information, has reinvented the apparatchik group into a real resource for investors, the U.S. Department of Health and Human Services, and public policy makers.
Lambert van der Walde, Capital Markets Advisor at CMS spoke at SMITH's annual Health Care Conference. A major theme of the conference was "access to capital". It's a subject CMS's acute care hospital report suggested is a key indicator of how an industry is performing.
"Without access to external sources of funds, a business is limited to only the excess cash flow it generates to fund its operations, maintain and expand its facilities, and invest in new tools and technology. The ability to access capital is critical for a hospital's future ability to serve its patients, build market share, and remain financially viable."
The U.S. Treasury has ruled the owners of HUD-subsidized housing developments will not have to pay taxes on the difference between market-rate loans and the below market rate HUD second mortgage loans that enable owners' current mortgages to be written down.
"Today's IRS ruling is good news for taxpayers," according to Housing and Urban Development Secretary Andrew Cuomo. "It will save taxpayers money by ending excessive rental subsidies, but still allow landlords to make a fair profit."
The ruling eliminates concerns by granting an exemption for HUD's soft-second mortgages.The ruling enables HUD to more smoothly implement the Multifamily Assisted Housing Reform and Affordability Act, also known as Mark-to-Market legislation, which President Clinton signed into law last October. The Mark-to-Market law is designed to cut subsidies to project-based Section 8 programs.
July 30, 2018, Vol. XXVI, Issue 14 Municipal Edition
The Global Economic Doctor
July 16, 2018, Vol. 3, Issue 12
— Mark Twain
Strong like Bull…For Now
Summary: The U.S. economy continues to be strong like a bull. Real GDP growth in Q2 2018 was 4.1% and July's unemployment was again under 4.0%. Corporate earnings for Q2 were also robust. Thus far a little over 80% of companies had better results than expected. The only sector to disappoint has been energy. Considering all of the above, we have upgraded our forecast for U.S. real GDP for the year to 3.0% (from 2.8%). We have also changed our view on interest rates: we think that the Fed will raise rates in September and it increasingly looks likely there could be one more hike in 2018, probably in December. We are also think that the 10-year Treasury yield will trend higher and could hit a 3.2-3.3% range by year-end.
Trade remains the potential spoiler. For most people Mark Twain summarized their sentiment on the topic, "The more you explain it, the more I don't understand it." To simplify, the U.S. is in a trade war with China, which puts the world's two largest economies at loggerheads. At the same time, the Trump administration has re-imposed economic sanctions on Iran. Foreign companies have to decide — either trade with the U.S. or Iran. Trading with the latter will result in punitive measures from the U.S. China, Russia and India have already indicated that they will still trade with Iran and Europe is taking measures to protect its companies that may still want to do business with Iran. Although the U.S. and Europe recently brokered a truce over trade, Iran sanctions are strongly opposed in Europe, which could complicate matters again. Rounding out the picture, the U.S. is considering further economic measures against Russia for its meddling in U.S. elections and the near-fatal nerve agent attack in the UK.
Another point of concern (not quite yet a spoiler) is the deteriorating U.S. fiscal picture. According to the U.S. Treasury, government receipts fell 7% in June compared to the same month last year, including a 33% drop in gross corporate taxes. Individual withheld and payroll taxes were down 5% from June 2017, while non-withheld individual taxes rose by 7%.
The budget deficit is set to continue to widen as government spending outpaces revenues. The budget gap was $607 billion in the first nine months of the 2018 fiscal year, 16% larger than the same point a year earlier. The idea of a $1 trillion budget deficit is no longer science fiction. The U.S. needs buyers of its sovereign debt as the anticipated gap between spending and revenues becomes more pronounced. The trade war with China could become even more complicated if the Asian country decides not to be a buyer in new Treasury bonds. China is the largest buyer of U.S. sovereign debt (holding a little over $1 trillion in Treasury bonds).
What to expect for the rest of 2018? The U.S. economy will remain strong, which will help push markets marginally up; but there will be a strong undercurrent of trade and geopolitical risk factors that can pull the global economy off track. We also have an eye on the rising tide of U.S. Treasury bonds, something that could begin to crowd out other asset groups. If nothing else, it can be said that the remaining months of 2018 will be interesting.
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