- How to handle and what impact it will have
- Better planning for pricing/GMP pricing negotiations
Dan Aschenbach (00:06):
We're gonna start this afternoon's panel on examining the impact of inflation and recession, and it's a good panel. First, wanted to have each panels introduce themselves. I thought that would be a better way of approaching this. So Doug?
Doug Kilcommons (00:21):
Sure. Good afternoon everyone. Doug Kilcommons from KBRA. I have a managing director in the US Public Finance Department.
Kurt Krummenacker (00:28):
Kurt Krummenacker. I'm Associate Managing Director at Moody's. I'm Manager of the Project Finance and Infrastructure team.
Elizabeth Reich (00:34):
Hi everybody. Elizabeth Reich. I'm the Chief Financial Officer at Dallas Area Rapid Transit.
Dan Aschenbach (00:41):
Well. In preparing for this session, I read chairman of one of the boards talk about the inflation will be cooling off over the next several years, and that struck me as a concern, but I think the last few days it's been pretty good. Seems to be reached a peak, but then again, so I just wanna make a few comments as we proceed. I feel myself dusting off knowledge and experience from the past to better understand today. For example, how many of you know what a basis swap is or a wrong way, hedge or asset liability matches part of an interest rate. Swap analysis terms and definitions that are old and old files are having to be brought out to training classes for today's analysts to talk about inflation, interest rate hikes and those risks and potentially recession as an analyst that covers electric utilities. I have my own small consulting firm, AGVP advisory. I evaluate and look at the new strategies that are present. And one thing that continues to come up these days is the impact of inflation. Even with for example, the new Federal Inflation Reduction Act there's a significant amount of new federal dollars for clean energy investments coming. Most of those projects have to be into construction by 2025. What's happening is that there's a significant higher cost of turbines solar panels and increases in construction costs from the Energy Information Administration. If I could find the exact percentages. The new build onshore wind row 7% year over year as of June fixed access solar jumped 14%. Battery levelized cost was up 8.4% and cost increases are due to cost of materials, fuel and labor. So, as that act starts pumping out this money there is a lot of concerns in the development stages of how inflation is gonna affect what projects can get done. And particularly as customers are somewhat shell shocked right now after being through a pandemic and natural gas prices that are more than double they were the year prior there's a weirdness about raising rates to fund new projects. So there's projects that are being delayed to get into the electric queue. For example, in the PJM market there's a long delay and with I just read this morning New Jersey PSE and G has announced their ending participation and the offshore win because of inflation and the higher construction costs. So, the last couple day or last day has been a lot of optimism about the municipal market. I guess the inflation is one of those things that is a cloud that's still there and we'll see where that goes. So, today we have some infrastructure experts to talk about this issue and we're gonna get started with each saying a few comments about themselves and this subject Kurt.
Kurt Krummenacker (04:22):
Sure. Okay, So I think the theme as Moody sees it is really one of uncertainty and that's the one I'm gonna kind of go through on my thread here as I talk for the next couple of minutes. We really see the global economy is kind of on the verge of a downturn. Obviously there's lots of things contributing to that. Persistent inflation as Dan mentioned, monetary policy tightening kind of on a global scale, fiscal challenges, geopolitical shifts and I mean the financial market volatility. We do believe that the inflation will as Dan was referencing, kind of start to taper off going forward. So we saw maybe the first green shoots of that here in the most recent announcement. But, we do expect that going through 23, that inflation will kind of start to come back down to something. I think we're in the two's maybe high two's for 23. But at the same time, global growth is also going to decelerate. Some economies will dip into recession, some will not. Our expectations that the US will not, but growth will be quite sluggish and be pretty close. So, there's just this continuing uncertainty as to how that all shakes out across the globe and the risks remain very high. We can all tick them off. Escalation of Russia, Ukraine volatility of energy prices real estate sector issues and so on and so forth. The emergence of covid, which isn't really a hundred percent behind us. So, there's a lot of uncertainty. What we feel certain about is that the credit cycle has turned that there is a credit downturn that we're already in. Regardless of how the economy shakes out, we are expecting default rates to rise. We're arranging somewhere between 3% and 12% in a worse case in terms of corporate default rates which is a market increase from the current rate of 2.3%. We do expect commodity, the commodity price, slow down and sluggish consumer demand to continue to term sectors negative. A lot of our sectors have moved to negative over the course of this year. So, 41% of them are actually negative as opposed to 14% a year ago. But there are a lot of upsides still kind of hanging out there. The US consumers in a pretty good place saw a great chart the other day that showed that checkable deposits across the US are four and a half times higher than their long term average. So, where it typically has run about a trillion dollars in total checkable deposits, right now it's at four and a half trillion dollars. So, it's this huge kind of pile of cash that the American consumer is sitting on and most things that's really concentrated in the top three quintiles. So, it's the poor and lower income aspects of the consumer economy that are more exposed to not only to any of the S really particularly the inflationary cycle. In addition, household debt remains quite low. So, the American consumer is in a pretty good place to shoulder this on top of it. Given some of the changes in federal policy the IJA, the IRA we're expecting construction to continue not quite a pace, we're expecting growth to continue but at a slower pace. So construction spending was up about 7% this year. We're expecting it to slow down a little bit to about six and a half next year and then to about six and 4% in the following years. But it's going to be troubled by inflation, it's gonna be troubled by staffing levels, interest rates and commodity prices. But at the same time there's kind of a persistent underbuilt infrastructure.
(08:28)
What else? Low vacancy rates. Obviously the infrastructure bill is meant to address infrastructure, so that's going to pour a lot of money into the sector. So, we do see construction moving forward and some normalization in the overall commodity prices. Hot rolled coil has the prices which once spiked actually several times during the pandemic. And when Russia invaded, Ukraine is now coming back down to a normal more normalized rate along their 10 year historical average and we expect that to continue and steal rebar and such. And local aggregates really haven't are kind of moving in more in a normal direction compared to what we saw earlier this year. So our view is for the outlooks for the sectors and US public infrastructure right now we're positive for the transportation ones and stable for the power. Now we're reevaluating that for the upcoming year. This is the time of year where we issue the new outlooks.
(09:28)
I don't expect that we'll probably stay positive for those, but they demonstrate the point of strength that the different sectors are coming from the airport sector, which was hurt the worst during the Covid pandemic obviously received the most amount of federal funding and the recovery has come back to a pretty good place. And employments are running around like 97% of their 2019 levels right now. They were kind of artificially capped over the summer because of capacity constraints by the airlines with staffing shortages. Now that we're out of the summer peak season, that is no longer constraint. And so we've moved from kind of a 90% to a 97%. The toll roads rebounded pretty quickly with commercial traffic bouncing back during the pandemic very quick as people shifted from a services economy to a goods economy. So the toll roads are at a pretty good place and as always sitting on a lot of cash. The ports kind of an interesting, very tied into the global macro cycle and right now global shipping is cratering. However there is kind of the upswing of crews that's coming into help a lot of ports and we expect that crew that to continue in 2023. So I'm gonna leave it there and just use that as a demonstration of the two sides of the coin. And why uncertainty is our park right now.
Dan Aschenbach (10:58):
Doug?
Doug Kilcommons (10:59):
Thank you. So very similar in terms of the uncertainty that exists today as we look out in time I will say that two things in KBR a's view is are present and helping to shape how we're looking at credit as we enter again this uncertain environment. First and foremost, if you think about where we are today versus where we were in 2020 at this time, we're in a much better spot. If you remember reading from those days all of the gloom and doom predictions around airports and employments, we would never get back to travel until 2025. That was at a lot of different forecasts and projections, all of which never came to fruition. We we're seeing, as Kurt just said, about 97% of traffic is back and in some places many airports in the southeast in particular, traffic is way ahead of their 2019 levels. So, there's some positive news there on the bridges and toll roads, they have obviously held up the best throughout the pandemic. Commercial traffic came back first. There's been a resurgence in non-commercial traffic, just passenger vehicles at many US facilities now. And that's a trend that seems to be continuing beyond that. The seaport sector there was an article just this past week about the port of Miami basically looking to do more projects for cruise lines because the cruise market is back. These are all good signs. So when you think about again, where we were are today, it's actually not an all bad story, all bad news story. Now with regards to uncertainty and especially around inflation this is something that we've been seeing through the course of this year impact many of the credits that we rate not only in infrastructure and transportation, but across the board, healthcare, higher education and so on.
(12:49)
Even geo credits. You see that the cost of services going up as a result of these inflationary pressures. We're looking to see with certain areas of the country with regards to the labor market, how that fares because there have been certain places where it's hard to get people on staff and while there are many jobs that were held vacant during the pandemic, it's now hard to get people trained and put to work essentially. And Kurt mentioned it with the airport sector and the airlines. It's very real. What happened this summer, they had all of these buyouts for pilots and senior flight attendants only to watch the traffic roar back and not be able to bring people on quick enough. And it created the summer that many of us experienced delay wise in at airports. So again, there's a lot going on here. I will say that as you think about what you can do as you embark on a new project, thinking about putting together a capital improvement program, the things that you really should be thinking about first and foremost, are you building for the demand that's there today?
(13:53)
Are you building for some demand that is coming? If it's the latter, you probably would wanna rethink that. It's something that we ask of issuers if we hear a project or a set of projects that really is future focused and not based on what we would consider to be realistic demand. It creates questions especially around being able to handle the cost related to that. On top of that, I would also say that when you think about individual projects, do you have the ability to scale back or rescope a project if the environment changes? There are some cips that you will look at and it is very clear that they can do that. Things are segmented, you can delay a project and not put the entire program on a full delay. But there are others where you have to do everything because it just makes the most sense.
(14:38)
And then lastly, I'll say with that last comment one of the things that we did see successfully used during the pandemic by several of our infrastructure credits, a few on the airport side and a few and some other sectors really being able to take advantage of an environment where costs dropped, where you were able to get raw materials and get people to work at a much lower wage. A lot of projects were pushed forward and they accelerated certain aspects of CIP. So you would take advantage of the efficiency of doing things all at once versus trying to stage according to the original plan. Great example of this is LaGuardia Airport. Nobody expected that to get built as quickly as it did, but because of the pandemic and because of the fall off and travel, they were able to move much more quickly than anyone anticipated.
(15:31)
So even with the uncertainty and even in environments where it's not as favorable, there is the ability to potentially take advantage of some things that those environments put forward. Last but not least the way that K B R A looks at credit, we take a credit by credit approach in the sectors that we rate. We do not generally put sectors on negative, positive or stable outlook. We look at individual credits within those sectors and really value the role that management plays as part of the rating process. It is something that if you were to ask me what keeps a rating stable versus having a change, it's what management is able to do and to articulate when you meet with them. One of the things that I'd also say is that we, in the good times, you hear about the, okay, if the rainy day shows up, here's what we would do. And again, these are our plans just because when the rainy day shows up and you activate those plans, does it mean your credit is in jeopardy? A team that is planned for the worst case scenario has the ability to again, effectively implement a strategy when the environment is challenging, that's actually a sign of a very strong credit. So we do look at that and consider that quite heavily in our analysis. And again, management is a very important part of the rating process and certainly in managing an uncertain environment.
Dan Aschenbach (16:56):
Elizabeth.
Elizabeth Reich (16:57):
Thank you. As the issuer here, I'll go into a little bit of detail about some of the challenges that we face on both the expense side and the revenue side but I always feel like I need to start by almost apologizing because Dallas, Texas and the North Texas region are such a strong economy right now that what I have to say from the issuer perspective may be very different than a lot of other issuers around the country that have different revenues that they rely on or different types of economies. And so take what I say with a little bit of a grain of salt that we happen to be pretty booming right now. So in terms of inflation impact certainly staffing is one that we see a lot in terms of being able to recruit to retain the wage pressure to have staff. And in a transit industry you need bus operators, rail operators, et cetera.
(17:54)
And if you don't have those then you don't have a reliable service or a service that's providing the level of service that people are expecting. And so that's a big thing. But also in our capital side, the availability of the construction crews. So what we're seeing is fewer bids for projects and of course higher bids and sometimes even, I was talking with the director of the water utility at the city the other day and she said they've had recent projects where they've just gotten one bid because there is no availability in terms of people to do the work. Construction costs certainly are going up. And what we have seen, and we've been doing some analysis lately because we've got a big capital project and we've got some escalation requests from the contractor. In looking at it, we're seeing that inflation is really between about 15 and 26%.
(18:47)
And text dot recently put out a report that said the last two years has been 26%. But of course it varies by commodity. And some of the things that we have seen are, for example structural steel, 60% in 2021 plywood, 46% lumber, 42 reinforcing bars, 52. So some of these big items that we're using in these capital projects are really going quite high. Glad to hear they may be coming down, but from the issuer perspective, I've been paying these prices or at least having a lot of requests for modifications to contracts for escalations, et cetera commodity costs that are not related to construction. As again, I told you, I spoke with the director of Dallas Water utilities the other day. Chemical costs for them are really increasing and they usually had budgeted, I don't know, 25 million a year for chemicals. She said they raised that budget to about 39 million. It wasn't enough. They're expecting to spend about 44 million. And so that's a huge deal. And so switching to well, and then I guess I could say the cost of capital of course with rates rising now and other effects of inflation on pensions and some things like that, put pressure on issuers. But moving to the revenue side, inflation can be a little bit of a mixed bag so it can be a boon. So for sales tax dependent agency like is initially inflation is great, our sales tax are booming, we're coming in way over budget, people are out there still spending and they're paying the higher prices and we're reaping that benefit. And so then the question becomes when does that slow down? When does that turn around? It hasn't yet. We're still seeing just huge year over year growth in terms of sales tax receipts for the city of Dallas. They saw it in. And if you don't know, I was the CFO at the city of Dallas for six years prior to moving to DART in July. So that's why I'm talking so much about the city as well as about dart the city of Dallas, their property tax roles came in this summer with huge increases of course. And so that was expected they were able to cut the tax rate and still have plenty of revenue.
(21:04)
So that was just the inflation in the housing market. And has it come down well, prices have, I would say I guess the increase has started to decline, maybe even flatten out a little bit. And with rates where they are and people doing what they're doing in terms of home buying that will even out a little bit. But I think overall those property values are gonna stay pretty high. Enterprise revenue, you can raise your water rates, you can raise your sanitation rates, et cetera, to a point to cover your costs And an enterprise fund you would but are people gonna be able to pay it? And ultimately as a public entity, you have to think about that as well. So yes, inflation can be okay because you can cover your cost in an enterprise, but maybe you should do other things for a transit agency.
(21:51)
Fair box revenue DART is not fair box dependent. We are sales tax dependent. However we're still seeing of course an effect there of the pandemic and that is that ridership only at about 61% of where it was pre pandemic. But that's holding very, very steady. And perhaps we'll talk about that a little bit more if we get into recession because what that shows me is that that's how many people must ride my system. That is your transit reliant population that's probably in that bottom quartile that you spoke about that aren't able to handle things as well either. So, what does that mean in terms of the decisions I'm making on fairs et cetera. And in a recession I probably will keep most of that ridership, but at some point how do I regain some of the other ridership, particularly in a hybrid work environment. And so those are just a few of the issues on both the cost side and the revenue side that issuers are grappling with. And I'm sure there's much more we'll talk about.
Dan Aschenbach (22:57):
Okay, we can start off with recession. I alluded a little bit to Janet Yellen's comments this morning that she thought inflation will be around for a few more years and that kind of sent people into a little bit of panic at the same time, Amazon's cutting 10,000 jobs and other announcements of substantial job cuts. Inflation seems to have peaked and maybe coming down, but is the risk of recession sooner than what was expected and what public finance sectors would be impacted mostly by that? Anybody
Elizabeth Reich (23:41):
You want me to or someone go?
Kurt Krummenacker (23:44):
Is a recession panel. You had two bond analysts and an issuers saying things aren't that bad a silver lining. But I said muni's view is that we're not going into a recession, that's our base case. I mean obviously the risks are very high that we do tip into a recession. So certainly the risk is there. I think the real entertaining part of it is going to be all the debate about whether we're in a recession or whether we're not in a recession, right? Because this indicator is going to show you we're in a recession and that indicator's gonna show you we're not in a recession and it makes for great TV if you watch TV on the news. But I think it's safe to say we're in for a period of challenging economic times, whether you call it a recession or not. And I think I kind of outlined a number of those factors. Maybe I'll leave it to Doug. Elizabeth, I wanna talk about the sectors that are affect.
Doug Kilcommons (24:41):
Sure start. First. I would say that the KBRA view is that we are just uncertain at this time whether or not we will be in a recession. That if we are in a recession, what the depth of that might look like or feel like. So again, this word uncertain is still with us here and this question as well. But again, it's something that we just don't know. But there are obviously signs on both sides that suggest that we may be, but again, it's inconclusive at this point and I think Kurt makes a great point depending upon which statistic you look at on which day could read a completely different story. So, it really does depend in terms of the public finance sectors, I think any sector that is in that makes up muni land would have some impact from a recession you can take, even the strongest city credit, the ability to provide services will be challenged if we go into a recession transit, thinking about again, a system that has already been impacted by the Covid pandemic and now potentially with people losing jobs, ridership goes down, where do you make painful cuts to your system? Because at some point the federal stimulus money that's still in place is going to dry up. And that was supposed to have been the stop gap between the pandemic and when ridership came back to a new normalized level. So there will be impacts there. I'd also say on some of the revenue sectors healthcare and higher education, obviously these are sectors that are impacted by many, many things. A recession would certainly pressure college enrollments, it would potentially pressure the services that are being provided at healthcare systems. Again, if you have greater number of people at a hospital that are not able to pay their bills, that creates a huge financial burden for those facilities. So, there's definitely going to be impacts felt throughout, but as I said earlier, it will really depend on the specific credit within those sectors. You can't broad brush a whole sector because there are gonna be stars within those sectors that actually do very well. And again, a lot of that is gonna be driven by what management has done in terms of planning for these environments.
Elizabeth Reich (26:57):
So, speaking from both the city of Dallas perspective and DART perspective both organizations have used their covid money entirely for one time expenses. So either COVID related expenses in the beginning days of testing and vaccination and medical supplies and masks and those kinds of things for the city of Dallas with our first coronavirus relief funds. But then with the ARPA money entirely dedicated to one time funding as well, either water and sewer infrastructure, broadband or other public work works type expenditures. And at Dart similarly we have dedicated our COVID money to a one time distribution to our cities to advance mobility. So, to be used for programs to advance mobility. So it may be curb cuts and sidewalks within half a mile of a transit station or a bus stop may be things like that. And so we are not putting it toward operating expenses. Other cities and other transit agencies of course have had to really fill in that gap in terms of their operating expenses. But that's not been the case because our sales taxes stayed other than April of 2020 where it was immediate and massive drop. They recovered very quickly, recovered by September and then just shot up. So, for a sales tax dependent transit agency and the city of Dallas there was no need to really fill an operational hole. And so going back to the original question, what is the impact of a recession? And I almost think it doesn't matter for a public entity because in a recession our services are almost always more in demand. I mean, that's the time government has to step up for the people it serves even more than any other time. That's when people are at their most vulnerable when they need us the most.
(29:01)
And so no matter what kind of public entity you are you really have to keep operating, you have to try to keep your services at levels that people need, et cetera. And that may be very difficult to do. And I'm not suggesting that management teams don't have hard choices to make or make those choices, but at the same time, that's why planning comes into play so much is that we've got to be ready to withstand a recession if it comes. And so I think the key is for me anyway now in this current job is that ridership it's very clear to me that there are people who are going to need to ride our system no matter what is happening. And that's 61% of our pre pandemic ridership relies on us. And so we have to be a safe, clean, and reliable system for those folks. And that is our focus right now. That is our strategy. That is what we're putting all of our efforts into is improving safety, cleanliness and reliability right now. And when we have those pieces in a better state, and I'm sure you all know and you don't live under a rock, so you see the news about particularly safety concerns, concerns about unsheltered folks writing transit, et cetera. Those are real concerns for transit systems across the country. And so our goal is at DART is to deal with those concerns and then begin to go back after the other 40% of people who are pre pandemic writers. They may now have a different pattern, they may come in three days a week instead of others. And so how do we increase the ridership or regain the ridership? And that's gonna take convincing new and different people to ride transit. And so we're focused on the future in terms of transit oriented development in terms of making sure we have a system that people are gonna wanna ride and that's where we're putting our focus even in the face of a possible downturn or a recession.
Kurt Krummenacker (31:06):
Dan, can I jump off that? Sure. Cause I think that's, you make a great point. I mean your mandate as a public issuer is job one is to provide that service. And so typically in a recession that starts to come at odds from where Doug and I come from about about your credit rating and making sure that you've got enough cash or whatever it is that we're throwing, right? Yeah. Because you have to provide that service. And so normally we're during a recession those two kind of meet and there's a tug of war and that public mandate has to win. And so therefore there's a credit pressure that comes along with it. I would argue that interestingly as we enter this, call it a recession most public issuers are in a great spot to handle both of those things. And so therefore maybe it's because they were expecting the pandemic to last 24 or 25 and so they kept cash over here cuz they knew the rainy days were coming or they cut into their debt service and pushed it out further or took interest rate savings up front and so for the next couple of months, year or two.
(32:18)
And Doug also makes a good point about you. Not everybody's in the same boat but most issuers are pretty well positioned. And then interestingly again, the ones that tend to be hurt the most in the pandemic were the bigger issuers and they usually fare well better than the smaller issuers in an economic downturn. So, there's almost kind of a normalization here that may go on, but maybe it's kind of going back to the thing you don't often get to hear phone analysts say things aren't gonna be okay, but
Dan Aschenbach (32:48):
So Doug, maybe you could follow that with there's a concern that certain types of airports may be more exposed to a recession than others. Are there strategies, financial, operating or capital, these facilities can be employed to blunt that impact?
Doug Kilcommons (33:04):
Sure. So yeah, when we look across the airport portfolio and you think about the different profiles of airports US airports, we'll use that grouping. You've got anything anywhere from fortress hubs, international gateways, pure leisure destinations or established leisure destinations. You've got capital city airports, you've got small regional airports, you really got a hodgepodge that's basically encapsulated in the airport space. And each of those sub-sectors within airports accesses the capital market. So you will see regional airports go to market because again, they have capital needs the larger, they're larger peers and they've gotta finance those. So each of these airports is in the bond market from time to time or airport types are in the bond market from time to time. In terms of where we view the strongest within the sector would certainly be the airports where you've got a diversity of carriers where you're not relying on one carrier also fortress hubs. And you may be thinking, well, you just said you need a diversity of carriers, but how could you have that in a fortress hub? Very true. But you have to look beyond just the who the main player is in that market. If you see an airline that has been in that market, has built infrastructure in that market, generates a yield premium on flights that they basically fly out of that market that would argue for a hubbing scenario being less likely than otherwise would be if the airline was basically in the market and then pulls out or didn't generate a revenue premium for their flying. So forts subs could be very well protected in this as well. And then I would also say that we look at, for some of the leisure markets that have grown, and again as I mentioned earlier, that really grew since probably the latter part of 2020. And throughout 2021 with few interruptions really grew at amazing rates because you had a lot of new air service entering those markets and you had a lot of new air service by airlines that would never have thought about flying. Some of those routes actually put flights in it and they've suck around. So in those markets we are encouraged to see traffic that has remained relatively stable if not increasing over the course of 2022 and certainly up way up when compared to 2019. But the challenge there is figuring out, again, if we do enter a recession, how much of that traffic is gonna actually be there? Because there are plenty of examples in previous recessions where leisure destinations, even strong leisure destinations saw traffic fall off for a period of time. So figuring out what potentially may be transient in those established leisure markets is something that we look at and form part of our thought process in the sector. I will also say in closing on this, when we look at the capital projects that are ongoing at an airport again we're asking the questions around why are you built? Why is this facility necessary? Why are you adding these gates? What is this intended to serve? And in a few of our very large gateway airports that we speak with, we've actually asked the question around, well, you look at your historic traffic mix and you used to see a 50 50 split between international and domestic, that has now shifted to 70 30%. Has that made you rethink some of your CIP projects? Do you have that need for an additional FIS facility versus putting in more common use skates? You can get more passenger domestic passengers in and out. So, things like that we are thinking about and considering when looking at some of these projects in front of us. But clearly the credits that will withstand this to vest are again those airports with lots of diversity, strong O and D base some of the fortress hub that are proven through. Multiple economic cycles to have to be strong and stable. And then I would say at the weaker end, you probably will see some of the regional airports which have already been struggling through the pandemic continue to do so. Not only because of the pilot shortage issue, which has impacted the regionals, but also simply because if an airline is in a recession and you've gotta pull back flights, you're more likely to cut one of those smaller markets than you are your base for your fortress hub.
Dan Aschenbach (37:28):
Okay. Muni's rallied yesterday, so everybody's feeling better about things. But what are the potential risks that keep you up at night in the infrastructure sector right now given what we've talked about today so far? And what's kind of the one number one or two items that you have Elizabeth, maybe one?
Elizabeth Reich (37:57):
Oh, There's really nothing that keeps me up at night. I guess I probably have to say that rates of course are always an issue because it lowers your capacity. And so for example, the city of Dallas is about to embark on a project for a new convention center and how much has the capacity been affected by these rate changes? And before I left the city, we had priced in a lot of it but not this much. And so those are some concerns cuz that's a project that's going to go forward. And so that's leads me to my point that issuers don't generally have a lot of choice about when they issue because often they're going to do the project or they need to do the project or need to make the investment and they have maybe at the margins some leeway. They can go a little early, they can go a little later, but they're going to go. And so that then becomes a capacity issue and how do you fill the gap that you need? Do you engineer a different project? Do you find some other revenue source, et cetera. So I think that's what a lot of issuers will be grappling with.
Kurt Krummenacker (39:12):
Correct. Yeah, I mean as I was kind of alluding to earlier, similar to Elizabeth, I'm not really being kept up at night by anything on normal circumstances for the muni infrastructure sectors, even though they are pretty closely tied to the economy, which is all signs pointing red and down right now because of a lot of the legs that I laid out earlier. If anything keeps me up, it's probably cyber risk. And it is that unknown of the unknown I think particularly in the aviation space, there remains a lot of question marks about how serious cyber risk could become the most recent denial of service attack on airport websites. Kind of brought it home but sorry to the airport issuers in the room, how many of you get on the airport website before you go traveling? It's not really the central point of information. The airlines website would probably be a bigger impact.
(40:20)
The airlines operations network would be an even bigger impact. And then the federal navigation system of course is very big. Or the aircraft communication systems. I know there is a lot of work being done championed by the DOT with the DOD and Department of Homeland Security to ensure that there are kind of improving defenses in those mechanisms. But it's kind of similar to any other terrorist event in that the, no matter how much defense you play, the bad guys only have to win once. So if there's something that's keeping up at night.
Doug Kilcommons (40:58):
The other thing I would add first of all, also sleeping well like my panelists here. So, no issues there for the most part. But I would say that the thing that keeps me up at night because I reflect on how significant and severe and just surprising it was another pandemic or another version of the current pandemic because literally overnight all of the things that we were doing, work, socializing, all evaporated with the stroke of literally a week it was gone. And so I think about how quickly that got taken away and in many places, in many markets in many cities, how long it took economies to reopen, how long it took us to get in some parts of the country, vaccines rolled out, things like that keep me up at night because again, when you think about the public finance space and all of the sectors that were impacted by what took place over the last two years, that really is the scariest thing for me because it's something that it's hard to plan for. Yes, you can do certain things and yes, here's now this acknowledgement that we've gotta be ready for the next pandemic, but how can we really be ready for that if we don't know what that looks like? And again, that's what worries me is that there's something else like that out there that in a blink of an eye will change everything that we know that we're doing today. And who knows if that's down the road? Hopefully not. But that's what keeps me up.
Dan Aschenbach (42:28):
Okay. We have one more question I want to ask because many of the other panels that talk today about ESG. So I wanted to just ask Kurt will an economic downturn change Moody's approach to ESG scoring?
Kurt Krummenacker (42:46):
Well, yeah. So Moody's just recently have been going through the process of putting out an ESG scoring for all of our issuers. We're getting near the tail end, we're just getting through the infrastructure sectors for the muni. They came on pretty late because we don't believe that ESG is a major factor. So, we focused on those sectors where ESG has a bigger impact. Our scale is one through five, we have two being neutral and one being a positive risk. And then we've got three gradations of negative that each of the Es and G factors are playing into the rating. I don't expect anything to change on our end kind of wholesale, whether there's a downturn or whether there's not a downturn going forward because we believe that the ESG risks that we're putting to these scores have already been in place and for the most part been there for many years. I mean certainly they're evolving as all risks are, but we're really just trying to segment, identifying these risks into the ES and G buckets so that they're more easily identifiable for the investor community and the regulatory community. And so don't really, while they're going to continue to evolve, we don't really see the score in changing about rapidly.
Dan Aschenbach (44:03):
Anything from Doug?
Doug Kilcommons (44:05):
I would just say that we at KBRA take a different view on esg. We don't score or rank order. We see ESG as an extension of management and it's part of the conversations we have with managers around cyber, around governance issues issues of equity. Those are things that we have now added as part of our analysis just in terms of the management piece of various methodologies. And again, our view is that the credit rating should be independent of an ESG rating and trying to conflate the two is potentially confusing for the market. So, we have taken a different tactics as I've described. And I'd also say that Kurt raised a great point around cyber and that is something that I think when the whole ESG phenomenon really, really took hold in our market it was something that was a topic that was out there, but it was really not well known. And people considered it to be for many large issuers, a far flung risk that really wasn't prevalent. And they had information technology teams and they were covered. But as we've seen with some of the higher profile cyber attacks of late, that hackers are very adept. They find ways around different technologies, different protections. So, it is now incumbent upon management to really be aware of that. We have seen management teams expand out their IT function to really focus on the cyber piece of their business because it is so critical. Think about all the things we do online on various websites. It's so critical to an issuer being able to provide services and protecting the constituents that they serve.
Dan Aschenbach (45:50):
Listening today, it really does seem investors care about ESG and what rating agencies and your firm are doing. So, we have a few minutes left. Maybe we could take a few questions if anyone has a question.
Elizabeth Reich (46:11):
This has been a quiet crowd for two days, so.
Dan Aschenbach (46:14):
There might be five minutes we can't see. Here's one. Okay we have a microphone for you.
Audience Member (46:23):
I guess maybe I just wanna turn a little bit more to state and local government staffing. I mean really look at oh 809, state and local government employment didn't recover, excluding education really till the fourth quarter of 2019. You look at the job losses in the pandemic, non-farm payroll, private, that's fully recovered, but state and local seems pretty stuck on recovering. And, really what sort of challenges that have as we enter into, if we enter into a recession or in the current inflation environment.
Elizabeth Reich (46:57):
I agree with you, we're stuck. And it's not for lack of dollars to pay people. It is truly a recruiting challenge. It's just a tough market out there for every type of position. And so that's why we're having such wage pressure and doing compensation studies all over the place and even still finding trouble, not only of hiring but retaining and so you know, can hire hire, but if you lose the same amount of people, you don't make any progress. And that's what we're finding, particularly in police officers and in operators bus and rail operators. And so it's tough to turn the corner from a macro perspective. I'll turn to these folks.
Kurt Krummenacker (47:37):
Can I ask, does it make you focus more on technology solutions to offload where you can? Obviously you can't do that with that.
Elizabeth Reich (47:47):
You can't you might consider an autonomous vehicle pilot for some kind of solution there at some point.
Kurt Krummenacker (47:57):
More like a future systems leveraging.
Elizabeth Reich (48:00):
Sure it does. And listen, we're not great. Local governments in general are not great at being on the forefront of having the most automated everything. So whether it's financial systems or even travel payments, accounts payable, all those kinds of things, that's not a place where we tend to invest because we're focused on the frontline, we're focused on that service delivery that's being provided. And so there is, I think in many local governments, certainly the ones I've been in, a lot of opportunity for that kind of automation, which could eventually lead to, if nothing else, at least the staff being able to keep their heads above water.
Dan Aschenbach (48:37):
Okay. Anyone else? Any other questions? One more, well I think we can conclude. Thank you very much for your listening today.