Joseph Krist

Municipal Credit Consultant

PREPA TALKS CRASH

It was supposed to be a model for the overall restructuring of all of the Commonwealth of Puerto Rico’s debt. Whether that was actually going to be the case was the subject of debate. Right now, the model lies in pieces – crushed by the weight of pride, impracticality, intransigence, and irresponsible politics. So it seems as it was announced that negotiations to restructure roughly $9 billion of the debt of Puerto Rico’s power company collapsed late Friday, according to a statement from a group of creditors involved in the talks.

“Today the PREPA Bondholder Group put forward an offer to extend the RSA until February 12^th in order to give the Puerto Rican legislature more time to pass the PREPA Revitalization Act. Based on our direct and positive conversations with Puerto Rican lawmakers, we are optimistic that the bill will be passed and it was our desire to be as supportive of the legislative process as possible. In addition, we also offered to extend our Bond Purchase Agreement (“BPA”) with PREPA, under which RSA creditors would provide $115 million in additional financing once the energy commission approves the securitization charge, with a deadline of May 23^rd. This amendment to the BPA reflects a milestone that was previously agreed upon, and was included in order to help ensure the deal would get done – as the energy commission approval is a vital element of the agreement.

“Unfortunately, PREPA is choosing not to extend the RSA. Over the approximately 18 months that we have been negotiating this plan it has consistently been our desire to reach a fair, collaborative agreement that would benefit all stakeholders, including the people of Puerto Rico. The plan has been described as fair to all parties and beneficial to Puerto Rico – not only by key legislative leaders but by other decision-makers in the Commonwealth. This is why we were willing to offer these further concessions, recognizing the complexities of the legislative process. While it is extremely disappointing and perplexing that PREPA has chosen to take this stance, we continue to remain open to reaching a deal with PREPA and it is our sincere hope that they reconsider their position and assume postures beneficial to the people of Puerto Rico.”

The statement did not say whether the creditors would now declare PREPA in default. If they did so it would be by far the largest and most momentous default in Puerto Rico’s growing debt crisis. PREPA has a debt payment of about $400 million due to bondholders on July 1. It also owes about $700 million to two financial institutions that help to finance fuel purchases.

It is said that PREPA was still willing to keep the negotiations going and that the talks broke down because the creditors attempted to impose a new requirement in exchange for granting more time. Before the deal could proceed, the Puerto Rico legislature had to approve it, and some lawmakers argued that PREPA and its creditors were rushing to close the deal before the island’s new public utility commission had a chance to properly review it. This is the second “deadline” missed by the legislature. The creditors had expected the legislature to approve the deal in a special session in December. When that did not happen, they said they would wait until Jan. 22, and they offered $115 million to help finance PREPA while the legislature considered an enabling bill.

It is rumored that the creditors were willing to wait until February, but the new public utility commission was more likely to need until May. The debt exchange would have required PREPA’S first increase in its base rate for power since 1989. The public utility commission is so new it has never been through a rate-setting process before. In the meantime, the Commonwealth clings to its strategy of running out the clock in the hope that the U.S. Congress can be persuaded to bail out the Commonwealth.

ATLANTIC CITY FACING TAKEOVER

The recent troubles of Flint, MI have cast a negative light on the concept of state “takeovers” of the financial operations of municipalities. The well known troubles in Flint resulted in the reinstatement of local control by the State. The usually poor reception given to outside managers has been a factor in the length of time given to Atlantic City, NJ to resolve its own deep financial troubles. As we have previously documented, a long term trend of decline and consolidation in the City’s economic engine – gambling – has resulted in a serious financial bind. The City has toyed with bankruptcy in an effort to undo contracts with Civil Service unions and to renegotiate tens of millions of dollars in tax refunds.

For the City’s creditors, the presidential race may have driven the State – or more precisely, Governor Chris Christie – to intervene in the City’s finances one week after Christie vetoed an aid package for the city, and his spokesman issued a statement denouncing local leaders for being fiscally irresponsible. “Atlantic City government has been given over five years and two city administrations to deal with its structural budget issues and excessive spending; it has not,” the statement said. “The governor is not going to ask the taxpayers to continue to be enablers in this waste and abuse.” The Council and the mayor had been scheduled to hold an emergency meeting this week to discuss a court filing under Chapter 9 of the federal bankruptcy code. In New Jersey, cities must seek approval from the state’s Local Finance Board to file for bankruptcy.

The reality is that with the Iowa caucus coming up next week, the city’s falling into bankruptcy would have proved deeply embarrassing for Mr. Christie who has sought to present himself in the race as a responsible executive, tested by crises and capable of extracting major compromises from Democratic adversaries. The timing of the announcement is reflected in the fact that the legislation still needs to be drafted and passed by the Legislature and signed by Mr. Christie. As planned , it would give the state the authority to act on the city’s behalf for five years, including the right to negotiate, amend and terminate all labor agreements for the city.

The City government, which opposes a state “takeover” faces daunting challenges. Casino revenue has fallen by half since 2006, to $2.56 billion last year from $5.2 billion. Thousands of jobs have been eliminated. And now there is the possibility that state lawmakers might end the city’s monopoly on gambling by allowing it in North Jersey. All of this combines to increase the difficulty the City faces in dealing with a declining taxable property base and more than $150 million in tax appeals from just one casino, the Borgata.

PENNSYLVANIA BUDGET MESS DRAGS ON

In two weeks, Gov. Tom Wolf is scheduled to deliver a budget proposal for the 2016-17 fiscal year, despite significant portions of the current 2015-16 fiscal year still unfinished. The Republican-controlled legislature reconvened this week amid a 7-month-old budget fight that has left billions in school aid in limbo, but lawmakers took no action on budget-related legislation. Prior to his formal proposal, the Governor made some extensive comments on the situation.

Wolf said lawmakers have not figured out how to pay for the spending in a plan they sent to him before Christmas. “If we don’t fix the budget deficit by 16-17, there are going to be huge cuts in education, and huge cuts in local services, so that local taxes are going to go up and services are going to decline”. “So we need a real balanced budget, we need some honesty, we need fiscal responsibility. It’s not just me saying that, it’s the rest of the world looking at Pennsylvania and they’re going to watch us and we’ve got to get it right.”

Wolf signed $23.4 billion of the main appropriations bill in a $30.3 billion budget package that had been written by House GOP majority leaders. He call it emergency funding to prevent schools from closing and social service agencies from laying off more workers. However, Wolf vetoed billions for public schools to keep pressure on the Republican-controlled House to pass the bipartisan deal. The action did keep some school districts from having to undertake short-term borrowings but was too late for others. Many social service providers are struggling to maintain their finances as the process drags on.

As is the case in Illinois, this situation is all about the politics. That is the one factor that separates municipal credit from all other fixed income credits. Until that changes, the concept of full equality of ratings across all classes of fixed income debt will be essentially impossible to achieve. We would not be surprised to see one more downgrade of the Commonwealth’s rating before the budget process is finally resolved.

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

GREAT LAKES WATER AUTHORITY BEGINS OPERATIONS

With so much attention being focused on the City of Flint, MI and its problems with a tainted public water supply, it would be easy to overlook a major development  for the primary supplier of water to the greater Detroit metropolitan area. January 1, 2016 marked the launch of a regional water authority in Southeast Michigan.  The City of Detroit, the counties of Macomb, Oakland, and Wayne, and the State of Michigan have officially united to form the Great Lakes Water Authority (GLWA).  The new Authority was formed as a part of the Grand Bargain resolving Detroit’s bankruptcy. The new structure gives suburban water and sewer customers a voice in the management and direction of one of largest water and wastewater utilities in the nation.

GLWA begins management and control of regional water and wastewater services, while Detroit, like suburban communities throughout the region,  will retain control of water and sewer services within the City limits.  The GLWA has signed a 40 year lease with Detroit for $50 million a year. Detroit will use these funds to overhaul its aging infrastructure.  The lease also provides for a $4.5 million Water Residential Assistance Program to help low-income customers of GLWA customer communities pay their water and sewer bills.

The GLWA is comprised of six board members: two from the City of Detroit, and one each from Wayne, Oakland and Macomb counties, plus one representing the State of Michigan. The Authority also has a new old customer. In order to address the City of Flint’s needs for potable drinking water in the face of its crisis, it will return to its former status as a customer of the City of Detroit’s water system. It was an effort to avoid feared increased costs from the resolution of Detroit’s bankruptcy that drove Flint officials to seek a different water supply leading to its current dire situation.

PUERTO RICO AUDIT MAY FINALLY BE MADE PUBLIC

Office of Management & Budget Director Luis Cruz told reporters that the commonwealth’s audited financial statements for fiscal year 2014, which ended June 30, 2014, could be finally released within the next few weeks, as the process being conducted by KPMG nears its end. “[The audited statements] should be ready by the end of this month; first week of February,” Cruz said. The commonwealth’s audited financial statements for fiscal year 2014 were due in May 2015, and the government has previously missed self-imposed deadlines to release it.

Meanwhile, the Puerto Rico government budget for fiscal year 2016, which ends June 30, has been adjusted, from $9.8 billion to $9.27 billion, mainly as a result of lower than expected revenue entering the commonwealth coffers, the revised budget translates into roughly $250 million in additional, across-the-board government spending cuts, including such areas as healthcare, security, social well being and education. The $250 million figure also includes a $119 million adjustment in debt service under the budget, mainly as a result of the default on certain Infrastructure Financing Authority (Prifa) bonds.

Cruz stressed the budgetary cuts are being made without affecting essential services to citizens, while ensuring government employees continue to receive their paychecks. “In a surgical manner, we are adjusting the budget…affecting in the least possible way and ensuring essential services to citizens. At the same time, we also want to ensure government payroll is met each pay period, as well as the least impact on the economy. Those are the judgment elements in making this decision,” Cruz explained.

Fiscal 2017 starts with more than $1.5 billion in payments due July 1. Since the release of the Fiscal and Economic Growth Plan (FEGP) in September, the fiscal crisis on the Island has worsened, and the Commonwealth is now facing even larger estimated financing gaps in both the near and long term. Specifically, the General Fund revenues included in the FEGP have decreased from a previous estimate of $9.46 billion for FY 2016 to $9.21 billion; the estimated five-year projected financing gaps increase from approximately $14 billion to $16.1 billion, even with the inclusion of economic growth and the implementation of all of the proposed measures in the FEGP; and the ten-year projections estimate a $23.9 billion aggregate financing gap.

Melba Acosta Febo, President of the Government Development Bank reiterated that it expects to sit with creditors shortly and put forth a comprehensive restructuring proposal. The proposal will  include a comprehensive adjustment of its debt that reflects the Commonwealth’s actual capacity to pay its creditors over the long term. It continues to characterize lobbying efforts as being of  those seeking to lock in speculative gains but hope that creditors will sit and work on a solution that will allow investment in Puerto Rico and repay its creditors through growth in the  economy over the long run.”

NASSAU COUNTY TESTING THE MARKETS

A pair of troubled credits have recently released preliminary official statements in connection with the hoped for sale of debt. We have taken the opportunity to review them for updates on their relative precarious financial positions. The first is A2 rated Nassau County, NY which operates under the oversight of a state financial control board. The County hopes to refund $273 million of outstanding GO bonds and issue $120.3 million of new bonds and $23 million of bond anticipation notes.

The County is currently projecting a $24.9 million deficit for fiscal 2015. According to the oversight board (NIFA), it ran a deficit of $190 million in fiscal 2014. The County budget and rejected by NIFA. After a period of changes and legislative actions, a revised budget was submitted to NIFA which approved the proposed debt issue. The $2.92 billion budget is considered to have some 480 million at risk in the form of unrealized revenues and/or expense savings.

The County is still undertaking to resolve long standing issues related to required substantial property tax refunds and the unwillingness of the County legislature to enact increased property taxes. So long as the refund issues require external borrowings to finance and structural budget balance remains unattained, the County’s credit will remain under pressure. Investors may take some comfort in the County’s lack of legal authorization under New York State law to resort to bankruptcy.

CHICAGO PUBLIC SCHOOLS

The Board of Education of the City of Chicago is a more troubled story. A long history of budget difficulties, turbulent labor relations, and dependence upon the increasingly troubled State of Illinois have combined to pressure the Board’s finances over an extended period. The tax base supporting the credit is also the same as that supporting the City of Chicago and other tax backed credits which all have increasing demands on that common revenue . Like the City, the Chicago Public Schools also have substantial unfunded pension obligations that require increased revenues.

In addition, CPS estimates that its system requires some $4 billion of capital to maintain an aging and outdated physical infrastructure. The ability to reduce those needs through closings and other consolidation initiatives is hamstrung by a very difficult and complex political environment reflecting the dire economic straits of a huge portion of the student population. Those issues have challenged multiple city administrations and board management over many years. The result has been a steady decline in the credit’s relative creditworthiness and the bonds are now rated below investment grade without any external credit support.

Concerns about the Board’s credit have been heightened due to the ongoing lack of an enacted budget by the State. This has raised questions about potential impacts on the Boards cash flow and ability to service its debt. The Board expects to receive 92% of the statutory State aid anticipated in its current budget. It also expects to receive $597 million in scheduled block grants from the State. The lack of a State budget has made the receipt of some $490 million of additional aid anticipated in the current FY budget highly uncertain.

This has required the Board to undertake and consider a range of expense cutting actions to offset the reduced funding. In addition, the cuts have influenced the negotiations being undertaken with the teachers union. These negotiations are ongoing and include the recent participation of a mediator as the teachers have reacted negatively to proposals that would reduce the Board’s pension contributions. The teachers have threatened to strike in an effort to influence negotiations. The primary impact of a strike would be to reduce state aid according to a formula penalizing CPS 1/176th for each day there is no class. Some 5 weeks’ worth of the school year could be lost in the event of a strike.

The ongoing uncertainty led S&P to lower its rating on the district’s $6 billion of general obligation bonds this past Friday to B-plus from BB and left it on CreditWatch with negative implications “while it continues to monitor the board’s efforts to maintain sufficient liquidity to meet its financial obligations.”

In the midst of this effort to complete the bond issue, Gov. Bruce Rauner and Republican legislative leaders on Wednesday proposed a state takeover of Chicago Public Schools and permitting the troubled district to declare bankruptcy to get its finances in order, billing the controversial ideas as a “lifeline” and not “a state bailout.” As described by the GOP leaders, the legislation would allow the Rauner-appointed State Board of Education to remove the current Chicago Board of Education and create an independent authority to run CPS until it is determined the district is no longer in financial difficulty. The leaders said the change would add CPS to a state financial oversight law that it is exempted from but that applies to all other Illinois school districts. Another measure would allow school districts like CPS to declare bankruptcy, which could allow it to void union contracts.

House Speaker Michael Madigan and Senate President John Cullerton made it clear the Republican takeover plan is dead on arrival at the Capitol.  Madigan said in a statement. “Republicans’ ultimate plans include allowing cities throughout the state to file for bankruptcy protection, which they admitted today would permit cities and school districts to end their contracts with teachers and workers — stripping thousands of their hard-earned retirement security and the middle-class living they have worked years to achieve. “When Detroit was granted bankruptcy protection, retirement security was slashed for employees and retirees. That is not the path we want to follow in Illinois.”

This type of political infighting has hampered serious reform of CPS operations. Investors should not be fooled now into thinking that the Governor and his allies are looking at the bondholders are a primary interest. The Governor’s anti-union agenda (whether you are for or against it) has been at the core of the budget impasse at the state level and is at the core of the Governor’s effort to jump into the middle of this dispute. Like Pennsylvania, the Illinois crisis is as much a creature of ideological political considerations as it is about economic or financial realities. All in all a toxic mix for current and potential investors.

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

The first week of January usually is the start of the upcoming fiscal year budget cycle. The most visible sign is the release of the Governor’s preliminary budget proposal in California. This year is a bit different as two of the largest states – Pennsylvania and Illinois – have yet to complete the enactment of budgets for the current fiscal year ending July 1, 2016.

PENNSYLVANIA

The adoption of a partial budget in Pennsylvania has reduced some of the cash flow pressure on the Commonwealth’s school districts. The action has shifted attention to the Commonwealth’s own cash position. In a move that only the very weak state credits employ, the Commonwealth has announced a plan for the General Fund to borrow from other state funds to finance a potential negative balance of $922 million after the governor’s line-item veto of a budget plan allowed its expenditure.

The Treasury has announced the creation of a $2 billion line of credit to cover expenses of the Commonwealth’s General Fund. The $2 billion credit line is the largest ever extended by the Treasury to cover General Fund expenses, exceeding the second-largest credit line of $1.5 billion extended in September 2014. The announcement Particularly noted the public school subsidy being withheld during the Commonwealth’s ongoing budget impasse until the partial budget plan was signed last week, the Treasury noted the General Fund’s balance was artificially inflated and, without the loan, would have fallen into a likely negative balance until the tax revenue collection spike in the spring.

As of last week, the Wolf administration has borrowed $1 billion of the available funds to cover expenses. The funds were borrowed from Treasury’s cash investment “Trust 99” fund and any borrowed funds will carry a 0.6 percent interest rate, which is lower than the Commonwealth could have obtained in the private sector while also allowing Treasury to make a positive gain for taxpayers when the loan is paid back.

The credit line also had to be approved by Auditor General Eugene DePasquale, who noted the credit line is necessary due to the Commonwealth’s structural deficit. “This is the second consecutive year the state hit a cash flow problem and needs to borrow money halfway through the fiscal year. As I said 16 months ago, the need to borrow money this early in the fiscal year is a strong indicator that the commonwealth’s unsustainable structural budget deficit continues to grow,” he said. “The long-term structural budget deficit and this year’s budget impasse should be a wake-up call to everyone involved that it is time to come to a resolution on these critical issues.”

The Commonwealth will have to repay the loan by June 30, 2016.

LOUISIANA BUDGET WOES

With so much attention devoted to Puerto Rico’s default and budget standoffs in Illinois and Pennsylvania, it is easy for some more familiar weak fiscal performers to get lost in the noise. One of those is perennial credit laggard Louisiana. Louisiana’s budget woes are even worse than the incoming administration of Governor-elect John Bel Edwards had anticipated. The shortfall for the fiscal year ending in June 2016 is estimated at $750 million. The chief fiscal adviser to the Governor said that the administration has not settled on a plan for fixing the problems with the current fiscal year’s $25 billion budget, but it has not ruled out tax increases, which would need legislative approval.

New revenue estimates showed a continuing drop in oil prices and a slump in collections from corporate income taxes and sales taxes. He said a $1.9 billion shortfall is estimated for the next fiscal year, which starts in July. The departing governor, Bobby Jindal, a Republican who mounted a failed presidential bid, refused to support anything he considered a net tax increase and leaned on short-term budget fixes.

LITIGATION BEGINS OVER THE CLAWBACK

As we have predicted in earlier discussions of the Puerto Rico credit situation, litigation has been filed to test the validity of the “clawback” provisions supporting general obligation debt of the Commonwealth. Two insurers of Puerto Rican bonds that are now in default sued the governor and other senior officials on Thursday, saying they had illegally diverted money from some creditors so they could pay other creditors in full. Assured Guaranty Corporation and the Ambac Assurance Corporation said in their complaint that Puerto Rico had diverted at least $163 million that had been pledged to pay debts they had insured. Those debts were in the form of municipal bonds issued by three governmental authorities on the island.

The governor responded that the litigation was a sign that a dreaded “race to the courthouse” had begun, leading to “litigation pandemonium” as different creditors sought to enforce their claims on the island’s resources. He called on Congress to enact legislation that would give Puerto Rico the ability to take shelter in bankruptcy, where such creditor litigation would be automatically stayed. “With no legal framework to handle this impending litigation crisis, both the Commonwealth and its creditors will soon face the opposite of due process and rule of law,” Mr. García Padilla warned.

Last week, the governor confirmed the use of at least $163 million — slightly less than the earlier reported $174 million — to help make a large payment due Jan. 1 to investors who hold Puerto Rico’s general obligation bonds. That type of bond is given the highest payment priority by the Puerto Rican constitution. Mr. García Padilla diverted the money by issuing an executive order on Nov. 30, starting what is called a “clawback” of funds from lower-priority bondholders.

Assured Guaranty and Ambac contend that the clawback was unconstitutional, because it “substantially and unjustifiably” impaired their contract rights under the United States Constitution. They also said they had constitutionally protected property interests in the money, because they held liens on the pledged funds. They acknowledged that their liens were subject to being paid after the general obligation bonds, but said the use of the clawback was still unlawful under the circumstances, “namely, where other available resources exist from which the public debt could be paid.”

The two insurers asked the court to declare the clawback unconstitutional and bar the Puerto Rican government from diverting any more pledged money. Their suit was filed in United States District Court in San Juan. The three public authorities whose bonds have been affected by the clawback are the Highways and Transportation Authority, the Convention Center District Authority and the Infrastructure Financing Authority. Holders of those bonds received some of the principal and interest payments due Jan. 1, from debt service reserves, which is considered a technical default. The Infrastructure Financing Authority did not have reserves in place to make the payment, and Ambac stepped in and provided $10.3 million.

LOMBARD HOTEL

The troubles of Puerto Rico and Detroit have overshadowed the more traditional sectors prone to default in our market. In a more typical situation, the village of Lombard, a Chicago suburb, wants bondholders to agree to a proposed restructuring of its $190 million of hotel/conference center debt. The village has since January 2014 not paid on its pledge to cover revenue shortfalls needed to avoid defaults on a portion of the bonds issued to finance construction of the Westin hotel. The restructuring proposal was made to bondholders in October but disclosed publicly only in December. It would cancel $29 million of unsecured C series 2005 bonds.

A exchange has been offered to holders of $64 million A-1 series, $54 million A-2 series, and $43 million B series, each of which carries different security.

The restructuring was initiated by ACA Financial Guaranty Corp. — which backstops $19 million of the $54 million series — and Lombard officials. If they can convince bondholders to agree to the new capital structure, it could lead to a resolution through a consensual bankruptcy filing by debt issuer Lombard Public Facilities Corp., according to documents and city officials. Under the restructuring proposal, the Lombard Public Facilities Corp. would retain ownership of the project. Without a restructuring, the Series A and B bondholders have a mortgage claim if the project were to declare bankruptcy.

Like other suburban hotel credits relying on corporate conference events in various sections of the country, the property has long failed to generate the revenue needed to support its debt. It includes a 500-room hotel, two restaurants, 39,000 square feet of meeting and convention space, a 25-meter indoor swimming pool and fitness center, and a 675-car, four-story parking deck. Village officials are promoting the plan as a means to align hotel revenues with debt repayment while also preserving the hotel’s business prospects. The hotel is operated by Westin Hotels & Resorts, part of Starwood Hotels & Resorts.

“Given market conditions, the hotel’s operational and financial performance and its inability to service the existing capital structure, a comprehensive restructuring is needed to preserve asset value and maximize bondholders’ return,” the plan reads. “If a restructuring plan is not undertaken to solve the default, the asset’s value may further deteriorate, including the potential loss of the Westin brand.” The hotel’s capital needs are increasing with few resources to cover upgrades because its revenues now go primarily to repay the bonds.

As part of the restructuring, the village would contribute $2.5 million for capital work at the hotel and be freed of further obligations on the debt. Lombard has seen its bond rating negatively impacted as the otherwise affluent village saw S&P lower Lombard’s credit rating six notches to a speculative-grade B from BBB in February 2014. Lombard’s previous refusal to make up shortfalls came ahead of a July debt service payment when it declined to cover a $2.6 million gap. The trustees have long taken the position that the village is not legally obligated to burden its taxpayers. The Lombard Public Facilities Corp. drained reserves to cover the Jan. 1, 2015 payment on the A series which carries an indirect appropriation pledge.

Like many project refinancings, coupon rates and maturities would be adjusted to better match operating realities. In this case, the A-1 bonds would be broken into a “hard” and “subordinate” series with $32.7 million paying an interest rate of 5.25% and carrying a 30-year term and a $32.7 million subordinate series also paying 5.25%, but with a maximum term of 55 years. The A-2 series would be similarly divided, with $27.3 million paying 5.25% and a 30-year term, and a subordinate $27.4 million piece paying a rate of 5.25% with a maximum term of 55 years. The B series would be divided into an $18.5 million tax revenue bond series with an interest rate of 3% and a 30-year term and a subordinate $28.1 million series paying 3% with a maximum 55-year term.

The A-1 bonds paid initial yields of between 6% and 7% on term bonds due in 2015 and 2036. The A-2 bonds paid yields between 4.11% and 4.8% with the final maturity in 2036. The B bonds paid initial yields between 4.125% and 4.59% on the final maturity in 2036. The plan argues that additional benefits of the new structure include the maintenance of bondholder claims and of the bonds’ tax-exemption, and the creation of marketable and tradable securities.

The July 1 default marked the fourth default on the $43 million B series that carries the village’s appropriation pledge. No payments have been made on $29 million of C series bonds. The January 2014 default marked the first actual payment default and it gave bondholders of the A and B bonds the right to accelerate repayment but they have not done so.

Originally, the village pledged — subject to appropriation — to cover debt-service shortfalls on the Series A bonds before reserves are tapped. The backstop was first triggered in 2012. The B series carried a more direct appropriation pledge but reserves were tapped first before the village was asked to cover shortfalls. The village in 2013 tried to issue a $10 million new-money issue of certificates but investors showed no interest in a non-general obligation debt that would have been secured by any legally available and appropriated funds. Property tax caps limit the non-home rule village’s ability to use a GO pledge. Lombard has no near-term borrowing needs for capital expenses.

The restructuring marks the second attempt by the village to get bondholders to agree to a plan that giving the project more breathing room. A proposed tender of the Series A and C bonds that asked holders to take a loss in 2011 failed due to bondholders’ competing interests.

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

THE BALL DROPS ON PUERTO RICO’S CREDIT

Puerto Rico made $594 million in bond payments due this week but still defaulted on $37 million in interest. The Governor at the same time said that there is no money available for future payments, including $400 million due in May in bonds issued by the Government Development Bank. The Governor reiterated that Puerto Rico needs Congress to give the territory access to debt reorganization under federal bankruptcy laws. “I’m not asking for a bailout,” he said. “I’m asking for the tools to address the problem.”

He said the government would default on $35.9 million in Puerto Rico Infrastructure Financing Authority bonds and $1.4 million of Public Finance Corporation bonds. This is the second time that Puerto Rico has defaulted on Public Finance Corporation bonds. The government missed a $58 million bond payment in August.

The U.S. Treasury said in a statement that the default demonstrates the gravity of the island’s situation and the need for Congress to act. “Puerto Rico is at a dead end, shifting funds from one creditor to pay another and diverting money from already-depleted pension funds to pay both current bills and debt service,” it said. The government has already increased taxes, closed schools, withheld tax returns and taken other numerous measures to cut costs and generate more revenue amid a worsening economic crisis. The Governor said government officials will start meeting with creditors in early January to discuss debt restructuring.

Previously, PREPA officials said that two bond insurers had agreed to take part in a five-year restructuring plan for the Authority. The insurers’ involvement signaled that PREPA had found a way to satisfy its bondholders, who expected to be paid about $177 million on Jan. 1, without having to part with that much cash itself. On Jan. 1, the two participating bond insurers, Assured Guaranty and National Public Finance Guarantee purchased $50 million of new revenue bonds from PREPA; a creditors’ committee known as the Ad Hoc Group will purchase an additional $65 million worth of bonds. Those purchases will give PREPA $115 million of fresh cash, which it can use to honor a large part of its scheduled bond payment due that day. PREPA was to make the rest of the payment out of its own resources.

The restructuring plan resembles terms that were made public earlier this year. They called for giving PREPA five years’ worth of interest-rate relief, which would save the utility more than $700 million. In addition, the creditors have agreed to permanently reduce PREPA’s outstanding bond principal by more than $600 million, according to a summary provided by the utility. This would be accomplished through a debt exchange, in which the holders of PREPA’s current, junk-rated bonds could turn them in and receive new investment-grade bonds. This was facilitated when  the two bond insurers agreed to backstop with a surety. The idea is to induce  investors to exchange their old bonds for the new ones, despite the lower face value, by making the new bonds a better credit risk.

The debt exchange is not expected to take place until next summer, and, until then, the negotiators must clear a number of obstacles. The first is Jan. 23 — a deadline for the Puerto Rican legislature to pass enabling legislation for the deal. Legislators have so far shown little appetite, because they would also have to request a rate increase for PREPA. In addition, a large number of PREPA’s bondholders continue to stay aloof from the restructuring talks, perhaps hoping an even better deal might appear later.

The creditors on board so far represent about 70 percent of PREPA’s $9 billion debt; they include the Puerto Rico Government Development Bank, mutual funds, hedge funds, and banks that finance PREPA’s fuel purchases. The holders of the remaining 30 percent of the debt have not yet signed onto the deal, and it is not clear whether enough of them ever will, at least under the incentives proposed by the current deal. But one more factor is expected to come into play in the first half of 2016: the hope by some investors  that Congress is preparing to make some form of bankruptcy protection available to Puerto Rico.

“While the entry into these agreements is another important milestone in PREPA’s transformation, the transaction is subject to a number of conditions and contingencies,” said Lisa Donahue, PREPA chief restructuring officer. “Chief among them are the enactment of the necessary legislation, the approval by the [Puerto Rico] Energy Commission of PREPA’s rate structure and the securitization charges, execution of a successful exchange offer, and the achievement of an investment grade rating for the securitization bonds, the last of which will of course depend on a number of factors, including the overall situation at the commonwealth.”

Effectively  the bond insurers have put up some money, in particular for the surety bonds, as their contribution for the deal, whereas the bond holders are accepting delays in principal payments and cuts in the interest rates, as their contribution for the deal. The lines of credit holders and the Government Development Bank for Puerto Rico have agreed to accept either an extended payment schedule plus lowered interest rates or to convert to bonds and accept the bond holder deal.

Officials continue to publicly hope that the PREPA agreement may serve as a template for similar agreements between creditors and Puerto Rico’s other debt-issuing entities. Whether  the collateralized debt concepts may be applicable to the ‘super bond’ structure being considered for the rest of Puerto Rico’s debt  is an open question. The statutory and constitutional issues underpinning the security for the outstanding general obligation debt create legal and political issues and involve many constituencies with clearly conflicting goals.

The commonwealth, however, still  has over $2 billion in payments due from February until July 2015. These payments are approximately as follows: $402 million in February; $ 29.3 million in March; $40.9 million in April; $469.4 million in May; $ 71.3 million in June and $1.9 billion in July 2016. In July, specifically, the government must pay $779 million in general obligations. COFINA has a $318.3 million payment due in February. The Puerto Rico Electric Power Authority must pay $423.8 million this year; the Aqueduct and Sewer Authority $147.5 million; the Public Buildings Authority $177.2 million and the Highway and Transportation Authority $232.5 million.

ALASKA

With oil prices down along with oil production, the state is facing a huge shortfall. Two-thirds of the revenue needed to cover this year’s $5.2 billion state budget cannot be collected. The governor  has proposed the imposition of a personal income tax for the first time in 35 years.  Many Alaskans are not old enough to remember a time when oil did not provide for state expenses. Oil royalties and energy taxes once paid for 90 percent of state functions. Residents received annual dividend checks from a state savings fund that could total more than $8,000 for a family of four .

Gov. Bill Walker, an independent, is proposing to scale back those dividends as he seeks to get Alaska back on a stable financial footing with less dependence on oil. The Permanent Fund has paid dividends to residents every year since 1982, from $300 to $500 a person in the early years to more than $2,000 this year, based on the fund’s investments.

The income tax would be 6 percent of the amount an Alaskan currently pays in federal taxes, so a person who owed $10,000 to the Internal Revenue Service would also need to write a $600 check to Alaska. Dividend payments would be tied directly to royalties that decrease or increase with oil production. Because oil production is down, next year’s payout would be cut by roughly half under the proposal, to about $1,000 a person. The governor would also raise taxes on alcohol and tobacco and would collect new taxes from the fishing, mining, energy and tourism industries.

Legislative leaders said the governor’s plans would be given fair consideration. The speaker of the House has conceded that some new revenue stream is probably unavoidable. In a deep first wave of budget cuts this year, Alaska eliminated almost all capital spending. The president of the State Senate, who is also an employee of the oil giant ConocoPhillips, said that he thought deeper budget cuts were still necessary and that residents would accept new taxes only when they were convinced that the old pattern of state spending — wasteful and inefficient, in his view — had been permanently changed.

Opponents argue that the governor’s plan would disproportionally hit working-class Alaskans. Which sectors of the state are hurt, or spared, will also be on the table when the Legislature returns to Juneau in January. The income tax plan, for example, would primarily hit urban Alaska, where most jobs are. A sales tax, by contrast, which some lawmakers favor, is seen as hurting rural residents more.

PENNSYLVANIA GETS A HALF A BUDGET LOAF…

Gov. Tom Wolf used line-item vetoes to allow some spending called for in a $30.3 billion budget lawmakers sent him. The vetoes strike $6.3 billion from the plan, leaving $23.4 billion in spending. The idea is funding will be restored if Wolf and lawmakers can negotiate a final plan. Wolf didn’t support lawmakers’ plan and wants one that includes an education funding boost and new tax revenue to close the recurring budget deficit.

Public schools will receive part of their basic education subsidy, but the vetoes withhold about $3 billion. Most other programs remain intact. The vetoes flat fund community colleges and state-system schools (including Kutztown University), cutting a combined $31.3 million proposed increase. Most funding is provided for student loans and grants, but $59 million is cut. A combined $521 million in proposed aid to state-related universities — Penn State, the University of Pittsburgh, Lincoln and Temple — is not included. But that’s because that funding has not been approved, not because of a veto.

The vetoes withhold the lion’s share of funding for agriculture programs, cutting $68.8 million from areas like dairy and livestock shows and agriculture research. State prisons will receive partial funding, but about $939 million is withheld. Medical assistance will be partially funded with $2 billion withheld. The vetoes cut $9.7 million of what was proposed for health items such as newborn screenings, poison control centers and programs targeting specific diseases.

Wolf flat funded the Legislature and commissions and offices that support it, vetoing a combined $64.7 million proposed increase.

… HELPING SCRANTON SCHOOLS AVOID DEFAULT

The Scranton PA School District officially secured a $40 million bond, avoiding default on tax anticipation notes due last week. The bond has a 4 percent interest rate for 2016. Earlier in 2015, the district received a note of $18.5 million and secured another note for $14.3 million in November to make payroll through the end of the year.

Directors passed a $146.5 million budget for 2016 on Dec. 21 that increases property taxes 2.8 percent and borrows millions, delays debt payments and uses money set aside for large health care claims. The district will again use procedures delaying paying nearly $10 million in debt and pushing payments into the future. Once the state passes a budget and the district begins to receive state funding again, the district hopes to pay off the loan. Scranton has 10 years to pay back the $40 million per a court order they sought in early December and a state statute.

Without state funding, the district had been unable to repay the two tax anticipation notes taken out earlier this year. After Standard & Poor’s withdrew the district’s credit rating earlier this month because of the state budget impasse, it had been much harder for the district to secure a bond. The bond has to be outstanding for one year. So if the district receives its state funding within the first half of the year, they have to wait until Dec. 1, 2016 to pay off the bond. The 4 percent interest rate is set for one year only. Rates can change through the life of the bond or the district can seek to refinance, he said. It was structured that way to allow the district to pay back as much as possible once state funding comes through. Extra money left over after the TANs are paid off will go toward paying the district’s everyday operations and payrolls, among other expenses.

HAWAII RAISES SMOKING AGE

Hawaii became the first state to raise the smoking age to 21. There will be a $10 fine the first time anyone under 21 is caught smoking and a $50 fine for every offense after that. Store owners will face a $500 penalty if caught selling to a person under the age limit. The rising popularity of electronic cigarettes led to passage of the new legislation. Officials cited a University of Hawaii study that found e-cigarette usage among Hawaiian teens is triple the national average. Twenty eight per cent of revenues received by the State under the MSA are statutorily pledged to support debt service on revenue bonds issued on behalf of the University of Hawaii. None of the revenues have been directly securitized.

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