Joseph Krist

Municipal Credit Consultant

PR OUTLINES STRUCTURE OF EXPECTED DEFAULT

PR has finally admitted that it will default on January 1 when the Puertto Rico Infrastructure Finance Authority”s (Prifa) $35.9 million debt-service payment is not made. There are no reserves to cover the payment due to the clawback of the authority’s pledged revenue stream — the rum tax proceeds received from the federal government — to help the commonwealth meet the $331.6 million GO payment due at the same time. There is also  $115 million due Jan. 1 to cover Highways & Transportation Authority (HTA) debt, as well as a $9.5 million payment corresponding to the Convention Center District, but their trustees hold enough reserves to cover both payments.

Despite the clawbacks undertaken, there is not enough to cover the full amount due on the general obligations. The governor has been lobbying Congress to include a bailout in the omnibus budget bill before Congress. this has been ruled out by House leadership. The governor is resorting to threats of a humanitarian crisis and invocation of Puerto Rico’s historic wartime activities in an attempt to shame the Congress into action.

House Speaker Paul Ryan, R-Wis., said on Wednesday that the House will work with Puerto Rico to come up with “a responsible solution” for the island’s debt problems next Unfortunately, the governor has been most closely aligning himself with some of the least mainstream and influential House members. Help will be best earned on the merits, not the emotions.

SPEAKING OF THE MERITS

Recent comments by Antonio Weiss, counselor to Treasury Secretary Jack Lew  may be seen as encouraging those who seek to achieve Puerto Rico’s goal of reducing its debts through the political process rather than through good faith efforts. Last week, Mr. Weiss gave a speech that was seen as endorsing Puerto Rico’s view that the Commonwealth itself –  not just its corporations and municipalities – be given the right to declare Chapter 9 bankruptcy. They were also viewed by some as trying to undermine ongoing negotiations to restructure PREPA’s debt. Weiss used creditor negotiations with the Puerto Rico Electric Power Authority, which have gone on for about 18 months, as a “cautionary tale” in his speech and a reason why the commonwealth needs access to a bankruptcy regime to bring creditors to the table. He is said to have called the need for audited financials before helping a “myth” and said “even without fiscal year 2014 audited financials, the magnitude of Puerto Rico’s problems, and the need for action, are clear.”

We find those remarks to be disturbing at best. The ignorance of the need for such data, if it represents Treasury’s view, is stunning given the precedents established during the New York City crisis. We view any effort to grant the Commonwealth directly the ability to declare Chapter 9 as being detrimental not only to holders of Puerto Rico debt but to the municipal market as a whole.  We agree that the portion of the Treasury plan that calls for a federal restructuring regime through Chapter 9 is advocating for a retroactive change in law that would be unfair to investors.

Assured Guaranty recently expressed such a view very well when it said that “Had Puerto Rico been eligible to file under Chapter 9 at the time these bonds were issued, investors would have priced that risk into the bonds, and Puerto Rico would have had to pay higher interest rates,” he said. “There is no justification for initiatives that would retroactively undermine the Puerto Rican constitution and the legal right and remedies that were the basis on which bondholders agreed to provide financing for the island’s development.”

We do not believe that it is extreme to believe that should Puerto Rico be successful in its quest to obtain the right for the Commonwealth to go the Chapter 9 route, that some states would want the same ability. Chapter 9 would provide a politically expedient route for irresponsible legislators to avoid making good on years of pledges to their employees.

This belief is based on the political trends which have become clear in the four decades since the New York City crisis. These reflect the increased partisanship of legislatures across the country buttressed by the highly ideological views of Republican legislators across the country. The resulting inflexibility in the face of increasing costs, especially for pensions, seems to be a perfect storm of conditions for those who would seek to reduce payments to all creditors including general obligation debt holders.

We hope that the sanctity of contracts and constitutional pledges was behind the U.S. Supreme Court’s decision last month to review a local law that would give the island’s public authorities access to bankruptcy-like restructuring capabilities. Two lower courts ruled the law is pre-empted by federal bankruptcy law but Puerto Rico appealed to the high court. The commonwealth, whose public authorities are not granted Chapter 9 protections under federal law, is arguing that it should not be left out of the federal law but also have the same federal law prevent it from trying to fix the exemption.

ST. LOUIS THROWS A HAIL MARY STADIUM PASS

It is hard to discern what actually went on in St. Louis last week when it approved a municipal financing plan that may be as ugly as the uniforms worn by the Rams in their game last Thursday night. Under the terms, the city would finance $150 million of the overall $1.1 billion project. The rest of the funding would come from the state, the NFL and the team owner. The NFL contribution is pegged at $300 million.

Two problems: the Rams owner is busy pursuing a plan to build a stadium in Los Angeles to return the Rams there and the NFL reiterated its position that the premise of the bill approved on Friday that the league has committed $300 million to the Mississippi River stadium proposal “is fundamentally inconsistent with the NFL’s program of stadium financing.”

The comments of various St. Louis aldermen express the “untidyness” of the plan best. Alderman Antonio French, once a critic of the project, turned into a supporter after amendments were added  to the bill to include minimum  requirements for ethnic and gender based owned contractors to be hired to build the stadium. French said he doubts the stadium will be built. But he said he hoped St. Louis’ action would show a “good-faith effort to hopefully sway a few votes to prevent Kroenke(the owner) from moving to Los Angeles”. Alderman Megan Green, labeled the process of generating  help from construction unions as well as minimum minority inclusion component “legalized bribery.”  But the best comment may have been from Alderman Sharon Tyus who said “we’re like at the strip club…and the stripper is throwing the money back at  us.”

The plan is being driven primarily at the State level through a task force created by the governor. It is of interest that St. Louis County has withdrawn from any plan to finance a stadium even though it is in a much better financial position than is the City. The result is an excellent reflection of the wide disagreement over the wisdom of public stadium finance that makes these financings among the most contentious in the public finance industry. The league is expected to decide in January whether or not it views the total package as viable or whether to support Rams’ ownerships desire to relocate to the L.A. market.

The Rams are in competition to relocate to that market with the San Diego Chargers and the Oakland Raiders. It is unlikely that the league would place three teams in that market. Complicating the process is the fact that interests with the Chargers and the task force supporting keeping the Rams in St. Louis are represented by the same investment banker. The whole situation is almost as ugly as those uniforms.

CHICAGO HOSPITAL MERGER UNDER FEDERAL CHALLENGE

With the enactment of the Affordable Care Act and its emphasis on cost saving, many have felt that consolidation was the way to achieve the operating efficiencies necessary to constrain costs to health consumers. To that end, significant mergers have occurred between numerous large health systems. Not all mergers have been seen by federal regulators to be in the public interest. Such is the case in Chicago where a proposed merger of Advocate Health Care, the state’s largest health system, and NorthShore University HealthSystem, (both mid AA rated systems) would create a 16-hospital system that would dominate the North Shore area of Chicago.

The Federal Trade Commission said on Friday that it planned to block the combination saying “this merger is likely to significantly increase the combined system’s bargaining power with health plans, which in turn will harm consumers by bringing about higher prices and lower quality.” “Competition between Advocate and NorthShore results in lower prices, higher quality and greater service offerings,” the F.T.C. argues in the complaint filed in the Eastern Division of the U.S. District Court for the Northern District of Illinois. The F.T.C. took similar action to halt the merger of two hospitals in West Virginia in November and, earlier this month, teamed up with Pennsylvania authorities to try to stop a deal between Penn State Hershey Medical Center and PinnacleHealth System.

Advocate argues that because the hospitals’ market was dominated by a major insurer (Blue Cross Blue Shield), the systems were “price takers, not price setters.” The hospital groups say the merger would shift health care from the traditional fee-for-service model of providing high volumes of care for high payments to one focused on a streamlined system aimed at achieving lower costs.

The hospitals believe that the federal government is subjecting mergers of providers to more scrutiny than it does to mergers of insurers to the detriment of providers.

Merry Christmas!! Our next publication date is January 7. Happy New Year!!

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.

Joseph Krist

Municipal Credit Consultant

CHICAGO PUBLIC SCHOOL CREDIT UNDER MORE PRESSURE

After a series of downgrades this summer including two to below investment grade, the Chicago Public Schools credit is under pressure again. The Chicago Teachers Union has voted overwhelmingly to authorize their leaders to call a strike. The announcement was accompanied by the usual strong rhetoric from the union which only served to highlight the trouble that holds the credit down and sets the stage for another downgrade.

The union said in a statement,  “Do not cut our schools, do not lay off educators or balance the budget on our backs.” The teachers’ contract expired in June.  School administrators have threatened widespread layoffs as they deal with a half-billion dollar budget shortfall. The union, which represents close to 27,000 teachers and staff members, has said that the city is demanding changes that would result in a 12 percent cut to their compensation in the next three years.

The potential strike accompanies events in October when the former chief executive of the school system, Barbara Byrd-Bennett, pleaded guilty to accepting hundreds of thousands of dollars in bribes and kickbacks in exchange for steering $23 million in contracts to her former employer. The system has been notorious for both its contentious labor relations and managerial incompetence and corruption over the years.

Union and city officials would first have to go through mediation before a strike could take place. Under state law, at least 75 percent of union membership must approve a strike before it can be called.

PENNSYLVANIA BUDGET STANDOFF IMPACT ON SCHOOL DEBT

Standard & Poor’s says it has withdrawn its ratings on a state government program that helps school districts borrow by giving a guarantee to repay bondholders.

In a Friday note, Standard & Poor’s says Pennsylvania can’t ensure the timely payment of debt service because of the ongoing state budget stalemate. Many districts use the program to lower their debt costs but mostly poorer districts essentially rely on the state intercept program for market access because their own stand alone ratings are often too low for them to borrow at rates they feel they can afford.

Districts in this position are often the victims of long term economic deterioration that has negatively impacted their ability to raise revenues locally . These include big city as well as small rural districts. The larger districts serve huge pools of economically disadvantaged children through large and aging facilities that require capital to be maintained. The smaller districts have less diverse tax bases and/or aging populations that provide little, if any support for property tax increases to fund borrowings.

School funding has been at the center of the current budget dispute which has entered its six month without a resolution. The state auditor general’s office has tallied about $900 million in borrowing by Pennsylvania school districts to pay bills during the impasse.

NUCLEAR DEVELOPMENTS IN SC

South Carolina Public Service Authority (Santee Cooper) is one of two municipal joint action agencies undertaking financial participations in the development of new nuclear generation sources. Over the next three years, SC projects financing requirements of $2.1 billion for its 45% ownership interest in two new units at the existing Sumner Nuclear plant. Nuclear is a resource that many are looking to in order to address carbon emission issues that have been the subject of international negotiations this week.

The obstacles to nuclear power outside of the obvious post – safety issues have centered on the cost and financial risk associated with the construction of new capacity. The municipal market had much experience with these risks in the 1980’s when credit weakness and default plagued several joint action agencies involved in some well known nuclear construction projects. While much has been done in the area of design to address the safety and direct construction issues, there still  remains significant cost risk associated with financial participation.

SC is a good example. Work began on the Sumner expansion in 2008. By 2012, license and design related delays had resulted in increased costs of $113 million and construction delays of 11 and 8 months. One year later, additional delays of one year were announced. In 2014, additional delays were identified such that the units will not be completed until  mid 2019 and mid 2020. This will produce another $270 million of costs to the Authority. These could be offset by the payment of liquidated damages by the construction consortium but these damages are now capped b y agreement. This year the project costs were capped at $2.73 billion for the Authority reflecting its now 40% ownership interest in the project.

This history is instructive to other utilities considering additional nuclear capacity. Even with a streamlined approval and licensing process, along with use of a standardized design, the project will have taken 12 years to design and complete. The “smoother” licensing process still did not allow for limitations in cost and have not provided financial certainty for owners and operators. This despite the fact that SC is one of the financially stronger and well managed municipal utilities. It also has substantial nuclear experience.

WATER IN CALIFORNIA BACK IN THE NEWS

One of the ways in which water consumers in drought ravaged California have been coping with less water is to tap underground sources. Now that strategy is exposing a downside. Uranium increasingly is showing in drinking water systems in major farming regions of the U.S. West, including the major farming areas of California. The Associated Press has found that nearly 2 million people in California’s Central Valley and in the U.S. Midwest live within a half-mile of groundwater containing uranium over the safety standards.

Uranium is a naturally occurring but unexpected byproduct of irrigation, of drought, and of the overpumping of natural underground water reserves. In California, as in the Rockies, mountain snowmelt washes uranium-laden sediment to the flatlands, where groundwater is used to irrigate crops. Irrigation allows year-round farming, and the irrigated plants naturally create a weak acid that leeches increasing amounts of uranium from sediment at the bottom of aquifers.

The USGS calculates that the average level of uranium in public-supply wells of the eastern San Joaquin Valley increased 17 percent from 1990 to the mid-2000s. The number of public-supply wells with unsafe levels of uranium, meantime, climbed from 7 percent to 10 percent over the same period. USGS researchers recently sampled 170 domestic water wells in the San Joaquin Valley, and found 20 to 25 percent bore uranium at levels that broke federal and state limits.

It is difficult to assess the potential financial risk to water utilities throughout the state as there is limited data to rely on. One way of dealing with the issue has taken place in Modesto where the city of one half-million residents, recently spent more than $500,000 to start blending water from one contaminated well to dilute the uranium to safe levels. The city also retired a half-dozen other wells with excess levels of uranium. In California, changes in water standards  in place only since the late 2000s have mandated testing for uranium in public water systems.

WILL RATE HIKES OFFSET VOLUME DECREASES?

Municipal bond volume declined for the third consecutive month in November with refundings down over than one-third from the same month last year. They dropped 39.5% to $7.42 billion in 319 deals in November from $12.26 billion in 444 deals a year earlier. Long-term issuance dropped 21.6% to $23.19 billion in 834 issues from $29.56 billion in 995 issues in the prior year period, according to Thomson Reuters. This is the lowest November lower volume since 2000, when the monthly issuance $19.80 billion.

At the same time, new money issuance declined 1.7% to $11.93 billion in 449 transactions from $12.13 billion in 473 transactions a year earlier. Revenue bonds fell 17.1% to $14.22 billion, while general obligation bond sales dropped 27.7% to $8.97 billion. Negotiated deals were down 15.3% to $17.43 billion and competitive sales were lower by 26.8% to $5.62 billion.

Taxable volume was down 22.7% to $1.69 billion from $2.19 billion, while tax-exempt issuance declined by 24% to $20.42 billion. Minimum tax bonds more than doubled to $1.08 billion from $508 million. Bond insurance broke its trend of decreases, as the par amount of insured issues rose 16.8% to $2.09 billion in 121 deals from $1.79 billion in 147 deals in November 2014. Cities and towns saw an increase of 49.4% increase to $4.37 billion in 224 transactions from $2.92 billion in 254 transactions, while state governments, state agencies, counties and parishes, districts, local authorities, colleges and universities and direct issuers all saw large declines.

Swimming against the tide were sectors like the housing and public facilities sectors saw gains despite having a lower number of transactions, compared with November 2014. Housing transactions increased 23.7% to $1.19 billion in 35 deals from $967 million in 44 deals while public facilities issuance jumped up 46% to $1.65 billion in 49 deals from $1.13 billion in 57 deals. Housing and public facilities sectors increased in spite of their being a lower number of transactions, versus November 2014. Housing transactions increased 23.7% to $1.19 billion in 35 deals from $967 million in 44 deals while public facilities issuance jumped up 46% to $1.65 billion in 49 deals from $1.13 billion in 57 deals.

Our view is that initial fed moves to raise rates will be mitigated by a continued demand for tax exempt income by investors who are seeing bonds called at a faster rate than they can be replaced in the new issue market.

PUERTO RICO REVENUE SHORT AGAIN

Puerto Rico’s General Fund net revenue for November totaled $488.6 million. This is $15.4 million, or 3.2%, less than estimated for the month in the original budget for fiscal 2016. This is the third consecutive month that revenues have missed estimates. Fiscal year-to-date (July-November) revenues total $3.051 billion, an increase of approximately $149.5 million year-over-year, but $23.9 million below estimates for the same period during fiscal 2016.

Individual income taxes showed a $31.3 million decrease compared with November 2014. In fiscal 2015, the Treasury Department received $29.4 million in nonrecurring revenues associated with Act 77 of 2014, which granted a temporary period during which certain transactions, such as those involving individual retirement accounts (IRAs), retirement plans and other capital assets, could be prepaid at preferential rates.

VAT collections for November were $191.5 million, some $74.9 million more than in November 2014, the result of the increase in the VAT rate to 10.5% from 6%. VAT revenues were divided: $109.3 million, corresponding to the 6% rate, was allocated to the Sales Tax Financing Corp. (Cofina by its Spanish acronym) and other $82.2 million, corresponding to the 4.5% rate, was allocated to the General Fund.

Corporate income tax revenues registered an $8.2 million decrease. Non-resident withholdings, which include royalties from the use of manufacturing patents, registered a $21.9 million decrease. Actual revenues were $25 million below estimates. Foreign excise tax collections increased by $10 million year-over-year.

For excise taxes, alcohol taxes rose $4.9 million with motor vehicle excise taxes up by $7.6 million. This is the first year-over-year increase in motor vehicle excise taxes for a month in fiscal 2016. Year-to-date motor vehicle revenues decreased $31.9 million.

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.

Joseph Krist

Senior Municipal Credit Consultant

PUERTO RICO TROUBLES CONTINUE

Just as the storm surrounding the credit woes of Puerto Rico intensifies, the worst suspicions of the most cynical investors and observers are confirmed. U.S. Attorney Rosa Emilia Rodríguez-Vélez of the District of Puerto Rico announced that 10 Puerto Rico businessmen and government officials have been indicted for their alleged participation in several schemes to corruptly give things of value to public officials within the government of the Commonwealth of Puerto Rico in exchange for favorable treatment and awarding of government contracts to various corporations. The 25-count indictment includes charges of conspiracy to commit federal programs bribery and honest services wire fraud, wire fraud, federal program bribery, extortion through fear of economic harm, money laundering, false declarations before a grand jury, and obstruction of justice.

Among the indictees are the Purchasing Director of the Puerto Rico Aqueduct and Sewer Authority and the Administrator and Special Assistant for Administration at the House of Representatives of Puerto Rico.

Just when it needs to show that it is serious about tackling its problems, Gov. Alejandro García Padilla signed into law the commonwealth’s self-imposed fiscal oversight board. Several amendments watered down the original version including provisions that the five-member board will only certify or endorse, rather than control, the commonwealth’s fiscal practices, while investigative, approving and budgetary-control powers also remained toned-down. The board will certify if each monitored entity is undertaking sustainable fiscal practices and complying with the five-year fiscal and economic plan. Such entities may request the board to be excluded from its scope if certain criteria are met, including long-term fiscal health and not running counter to the FEGP. The legislative and judicial branches, PREPA and PRASA, and the University of Puerto Rico are not considered monitored entities, so they do not fall under the board’s review powers.

SUPREME COURT ACCEPTS PR RECOVERY ACT FOR REVIEW

The Supreme Court on Friday agreed to decide whether Puerto Rico, which is in the midst of a financial crisis, may allow public utilities there to restructure $20 billion in debt. Puerto Rico’s lawyers had urged the court to take immediate action in light of the overall magnitude of the commonwealth’s debts, around $72 billion, which it says it cannot pay. “Anyone who has even glanced at the headlines in recent months knows that the commonwealth is in the midst of a financial meltdown that threatens the island’s future,” the lawyers wrote in their petition seeking review of an appeals court decision that struck down a 2014 Puerto Rico law allowing the restructurings.“Because that decision leaves Puerto Rico’s public utilities, and the 3.5 million American citizens who depend on them, at the mercy of their creditors,” the commonwealth’s lawyers wrote, “this court’s review is warranted — and soon.”

The United States Court of Appeals for the First Circuit, in Boston, said the 2014 law, the Recovery Act, was at odds with the federal Bankruptcy Code, which bars states and lower units of government from enacting their own versions of bankruptcy law. Puerto Rican officials countered that the Recovery Act addressed a gap in the way its debts are treated. Chapter 9 excludes all branches of Puerto Rico’s government, including its public utilities. The Recovery Act, Puerto Rican officials said, merely filled the gap in the overall legal structure.

Creditors of the utilities sued, arguing that the Bankruptcy Code displaced, or pre-empted, the local law. So far, the courts have agreed. The decision to accept the case for review seems to have reinforced the government’s strategy of appearing to put all of its eggs in the bankruptcy basket so to speak. PR lawmakers were informed Saturday, Dec. 5, that the Governor  won’t be calling a special session to consider the Puerto Rico Electric Power Authority (PREPA) Revitalization Act bill, after all.

CONGRESSIONAL PROPOSAL ON PR

Senate Republicans introduced a bill Wednesday to include up to $3 billion in cash relief, a payroll tax break for residents of the island and a new independent authority that could borrow for Puerto Rico — but with no taxpayer guarantee. “Consistent with the views of Congress and the administration that there will be no ‘bailout’” of Puerto Rico, said a bill summary, “the full faith and credit of the United States is not pledged for the payment of debt obligations issued by the Authority.” “Consistent with the views of Congress and the administration that there will be no ‘bailout’” of Puerto Rico, said a bill summary, “the full faith and credit of the United States is not pledged for the payment of debt obligations issued by the Authority.” The legislation also included a provision to require Puerto Rico — and all the states — to disclose, for the first time, the true financial condition of their pension systems for government workers.

The bill provides for tapping a $12 billion public-health fund created under the Affordable Care Act, for research and preventive medicine programs nationwide. The bill summary said the money was as yet “unobligated,” and could be “repurposed” with federal supervision to help Puerto Rico through an expected cash squeeze this winter. The legislation was introduced by the Republican chairmen of three Senate committees with jurisdiction over Puerto Rico’s: Senator Hatch of Utah, whose Finance Committee has jurisdiction over tax policy; Senator Grassley of Iowa, whose Judiciary Committee is responsible for bankruptcy law; and Senator Murkowski of Alaska, whose Committee on Energy and Natural Resources has jurisdiction over matters involving America’s territories.

The bill would designate a “chief financial officer” for Puerto Rico to advise the island’s governor on drafting and sticking to an annual budget. The designee would remain in place even if the government changes hands in next year’s election, giving Puerto Rico a better chance of seeing through its five-year economic recovery plan no matter who is elected. The bill proposes only further study of  how to revive Puerto Rico’s failing pension system, or changing the way doctors on the island are paid by federal programs like Medicare.

By waiting until the end of the current Congressional session, the bill’s sponsors implicitly indicate that the measure is at best a band aid to fund the upcoming January 1 general obligation bond payment and provide more time for a more serious and comprehensive plan in 2016.

PA MOVES TOWARDS A BUDGET

The Pennsylvania state Senate passed a public pension reform plan Monday by a 38-12 bipartisan vote. Monday’s vote sends the bill  to the House for further action. For school teachers hired after July 1, 2017 and state workers hired after Jan. 1 2018, the bill creates a new, two-track pension plan that combines a reduced guaranteed benefit based on years of service and final salary at retirement with a separate 401(k)-style component. It also will change some rules pertaining to current employees, though the basic form of their pension plan would not change.

Pennsylvania union leaders immediately blasted the bill as unfair to future workers, and noted that it may have passed improperly without a required independent actuarial note from the state’s Public Employee Retirement Commission. Unsurprisingly, the leader of the largest state employees’ union, vowed to continue to fight against the bill in the House, and also promised a certain court challenge if passed because of the changes for current employees.

The  director of the Pew Charitable Trusts States’ Public Sector Retirement Systems project has said that his reviews showed that while retirement benefits for a career worker hired under the new bill’s terms would be reduced about 10 to 15 percent from present, with Social Security that worker could still expect to receive an average of about 90 percent of their take-home pay through the course of their retirement.

The new benefit would cut the current “defined benefit” pension formula in place for workers hired since 2011 in half, essentially guaranteeing new hires 1 percent of their final salary for each year served as opposed to the 2 percent multiplier in place now. That would be paired with a mandatory 401(k)-style piece, into which the state would contribute the equivalent of 2.5 percent of an employees’ salary to their personal retirement account. Between the two components, school district employees hired under the new plan would contribute 7.5 percent of their salaries to their retirement. Affected state workers would contribute 6.25 percent.

There is a carve-out for “hazardous-duty” workers, including state police, corrections officers, game wardens and park rangers, for whom the current defined-benefit plans would continue. Current state and school district employees would see changes including changes to rules regarding lump-sum withdrawal of individual pension contributions for any payments made into the system, starting Jan. 1 for state workers and July 1 for school employees. Also included were resets to the final salary calculation to the higher of average salary over the last three years of employment, excluding overtime; or the average of the last five years’, overtime included.

The bill includes an adjustment up to workers’  payroll contributions by 0.5 percent if, over the prior 10-year period, the state’s two major retirement funds have missed their investment return targets by a full percentage point. On the other hand, contributions would be cut by a half-percent if investment gains beat targets by 1 percent. The review would be applied once every three years. Actual savings from the reform bill are small: the Senate released an analysis Monday putting the number at $2.6 billion over the next 20 years, against a cumulative cost of over $200 billion. As a result, other budget issues will have to be relied upon to stabilize the Commonwealth’s finances and ratings.

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.

Joseph Krist

Municipal Credit Consultant

PUERTO RICO

Debt service may have been paid but the Puerto Rico debt crisis entered a new phase. The government of Puerto Rico was able to meet in full a $354.7 million payment on outstanding Government Development Bank (GDB) notes due Tuesday, Dec. 1, the governor’s fiscal team announced that certain revenues pledged to pay debt held by five public entities will be “clawed back” due to the severe cash crunch affecting the commonwealth.

Executive Order 2015-46, signed Monday by Gov. Alejandro García Padilla, allows the central government to use revenues that cover debt service of certain public corporations — the Highways & Transportation (HTA), Infrastructure Financing (AFI), Metropolitan Bus (AMA), Integrated Transportation and Convention Center District authorities — to pay debt carrying the commonwealth’s guarantee. In all, the government would claw back about $329 million in such revenues for the payment of commonwealth-guaranteed debt and would allow to maintain essential government services, officials say.

This opens the door to potential litigation by creditors of the impacted agencies that would test the validity of the “claw back” now that it has been used for the first time.  GDB President & Chairwoman Melba Acosta said the Dec. 1 payment was met using the bank’s funds and is intended to show its creditors Puerto Rico’s willingness to honor its obligations as it continues to seek a consensual debt-restructuring deal. Puerto Rico’s liquidity position continues to be “severely constrained” despite the extraordinary measures.

At the same time, revenue estimates for the current fiscal year have been further adjusted, about $508 million less than originally projected in the commonwealth’s budget for fiscal year 2016, from $9.8 billion to $9.3 billion. In a government quarterly financial report released Nov. 6, the administration had already hinted at the possibility of the “claw back” through which it could tap these revenues to pay debt guaranteed by the commonwealth. Citing the Puerto Rico Constitution, the government could do so “if there is an insufficiency of available resources to meet debt service on general obligation debt.”

“In the case of the contracts where a clawback could be carried out, they provide that if there is a need of cash flow to pay debt with more legal protection and government services, a clawback can be executed,” Secretary of State Víctor Suárez said.

Meeting the Dec. 1 GDB payment proved to be a challenge for the government, with several payments looming , and as soon as Jan. 1, the administration would have to come up with more than $600 million if it is to meet all its debt obligations that come due on New Year’s Day. Primary among those Jan. 1 payments, the government faces $331.6 million due on general obligation (GO) debt. There is also some $115 million due on HTA debt, about $36 million due on Infrastructure Financing Authority (AFI) and $9.5 million corresponding to the Convention Center District Authority.

The GDB said that despite the  decision to claw back revenues pledged to the public corporations, they would still have enough resources to meet their debt-service schedule. “What we are doing is clawing back on the money that goes to the trustee. Most of these agencies have sufficient reserves to pay their scheduled debt service payments. Not sending the money [to the trustee] doesn’t necessarily mean that we are not going to pay that debt. Each entity is different. The executive order was signed yesterday, and the first clawback was yesterday, of some $22 million that was going from HTA to its trustee,” Acosta said.

The action was concurrent with a U.S. Senate hearing on Puerto Rico’s problems. According to the testimony submitted by Governor García Padilla for the  hearing over the Puerto Rico fiscal crisis, the governor stated that “in simple terms, we have begun to default on our debt,” as a result of his decision to sign the order that allows for the clawback. Other spokesmen for the Government were more equivocal saying, “According to each contract, there are different definitions on what a default would be. From a technical default, to a default or a breach of contract, there are different definitions”.

The  Justice Secretary César Miranda said the administration’s decision to use these pledged revenues to pay other public debt “could be interpreted as a technical default, in the way that we are retaining money that would have been used to eventually pay a debt when it’s due. Certainly, the debt hasn’t matured. When it is due and not paid, then there could be an absolute default. Someone may interpret that retaining the money that would have been used to pay certain debt could constitute a default. It is questionable legally, and would depend on what is stated under each particular contract.”

ILLINOIS FINDS SOME CASH

The other large troubled credit made some level of progress this week. Gov. Bruce Rauner and House Democrats on Wednesday came to a rare compromise to release more than $3.1 billion to pay Illinois Lottery winners and help cities and towns operate 911 centers, plow roads and train firefighters. Normally, municipalities receive a share of gas tax, 911 surcharge and gambling revenue to finance up day-to-day operations.  Those dollars have been on hold due to the state budget impasse. Legislation passed 107-1 by the House would free those funds. Of the total, $1 billion would be for the lottery which had stopped making large payouts because the state hasn’t had a budget since July 1.

The bulk of the $3.1 billion in new spending is money set aside in accounts earmarked for specialized purposes, though lawmakers also signed off on $28 million in spending from the state’s main checking account. About $18 million of that will go to domestic violence shelters and another $10 million was set aside for the Secretary of State’s office, which stopped mailing yearly reminders for drivers to renew their vehicle registrations.

By year’s end, Comptroller Leslie Munger projects the backlog of delayed bill payments could reach $8.5 billion. Areas that remain unfunded include colleges and universities, scholarship programs for low-income students and various programs for victims of sexual assault and those with developmental disabilities.

Rauner said he would support the bill if it also included more money for things like debt payments and salting and plowing of roads.  He billed the move as a compromise, although it also provided him political cover as some House Republicans were willing to vote for the plan in the face of pressure from suburban mayors to free up the money. Following Wednesday’s House vote, Rauner said there were some things in the bill he liked and some things he didn’t, but “what we did is we compromised.”

The Senate is scheduled to return to the Capitol on Monday of next week to vote on the legislation. Rauner and Democrats also were able to find common ground on a bill that could make workers ineligible for unemployment benefits if they do things like drink on the job, lie on an employment application or refuse to follow an employer’s instructions.

It says a lot that those last items represent a real achievement in Illinois budget politics.

MEDICAL FINANCING POLITICS

If there is one industry that has faced more challenges to its at ability to plan financially over the last two decades it has to be the healthcare industry. This week will present yet another example. It is likely that as we go to press that the U.S. senate will use the reconciliation process to approve a repeal of Obamacare. It would represent the first  time in the six year history of the ACA that both houses approve such legislation. It will have no practical impact as all involved agree that the bill will be vetoed and that the votes to override such a veto are not to be had. It will however thicken the cloud that hangs over the law and add to the uncertainty about exactly what pool of revenues will be available to hospitals and other providers going forward over the long term.

The other headwinds are pretty well established and have been highlighted during the current enrollment period for coverage for 2016. Between stories about higher premiums, fewer insurer participants, and the possibility of changes under a new administration in Kentucky the stream of news about the ACA has not been positive. Of course this excludes the fact that millions of Americans have gotten health insurance and that the % of Americans uninsured is at a multi-decade low.

All of these factors conspire to make the job of hospital CFO more unenviable by the day. Our view is that they combine to continue the support for scale on the part of providers although scale without efficient use of technology, especially in billing is not a sufficient panacea. In fact, technology at any facility whether it be large or small, urban or rural, is a key issue. Having said that, smaller and stand alone facilities will remain the most vulnerable to the uncertainties inherent in the battle over the ACA. we believe that investors should keep that in mind as they continue or consider their investments in credits in this sector.

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