Joseph Krist

Municipal Credit Consultant

KENTUCKY BUDGET MAKES SOME EFFORT AT PENSION FUNDING

The Kentucky General Assembly has passed a $21 billion Executive Branch budget for the next two fiscal years that will pour $1.28 billion into the state pension systems and make no cuts to K-12 education while authorizing the governor’s plan to cut most state agency funding by nine percent over the biennium. Most new money in HB 303 will go for state pension in the Kentucky Employees Retirement System and the Kentucky Teachers’ Retirement System. Funding in FY 2017 will be $933.1 mn and in FY 2018 will be $888.8 mn. That is 5.7% of enacted spending for the upcoming biennium.

Funding for K-12 education will not be cut under HB 303, which protects funding to schools and gives the Department of Education up to $20 million in additional funds over the biennium as a necessary governmental expense if there are not enough per-pupil SEEK funds available. Public preschool will be made available to families with incomes below 200 percent of the poverty level as part of a pilot program, and $15 million in preschool funding will be set aside for grants to help develop full-day programs for children eligible for state child care assistance.

In the area of higher education, HB 303 authorizes lesser cuts of 4.5 percent over the biennium for state colleges and universities that faced the possibility of 9 percent cuts under the governor’s original proposal. A performance-based funding formula for state universities is also found in the bill that will require 5 percent of state university base funding to be gauged on an institution’s performance. Kentucky State University would be exempt from the performance-based model.

LOUISIANA

On April 12, 2016, Louisiana Governor John Bel Edwards released his proposal for the state’s fiscal year 2017 budget. Citing shortfalls in the state budget, Edwards said that deep cuts to many state services were necessary to close gaps for the overall improvement of the state’s financial health. The proposal included cuts to the state’s primary college scholarship program (TOPS), cuts to “safety net hospitals” for low-income families, and cuts to education at both the K-12 and college levels. The funding for the TOPS program, in particular, would be reduced by about two-thirds of its current level, leaving the total funds at about $110 million. The state legislature went on to debate several bills that would alter how  cuts.

The cuts followed up a series of tax increases adopted during a special session of the legislature in late winter. These included a rise in the State sales tax rate of 1%, an expansion in the taxable base for the existing 4% sales tax through FY 2018, and the stabilization fund and appropriated $200 million of monies from funds received under the BP settlement agreement.

According to the U.S. Census, Louisiana had 14 state pension plans as of April 2015. Between fiscal years 2008 and 2012, the funded ratio of Louisiana’s state-administered pension plans decreased from 69.2 percent to 55.5 percent. The state paid 96 percent of its annual required contribution, and for fiscal year 2012 the pension system’s unfunded accrued liability totaled $18.4 billion. This amounted to $4,161 in unfunded   liabilities per capita.

The State continues to be negatively impacted by low oil prices. These have had a negative impact of revenues and employment and increased pressure on the expenditure side of the budget. So long as oil prices remain in a relatively depressed state, the negative pressure on the State’s credit ratings will persist. These are exacerbated by the State’s weak pension funding position reflecting years of underfunding now creating annual budget gaps.

RHODE ISLAND PENSION DEVELOPMENTS

So far this year’s budget process has not continued positive momentum which the State and the Governor had hoped to carry forward in regard to the State’s longstanding pension funding issues. In 2007, legislation was enacted which provided for surplus General Fund monies to be transferred to the State Retirement Fund. Pressures on the General Fund diminished support for this plan as it was felt that the funds were needed elsewhere and last year the Legislature effectively repealed these provisions keeping those surpluses within the General Fund.

Most prominent among those pressures were the need for additional state aid to struggling municipalities. Those struggles are based in changes in the local economies but also fiscal pressures resulting from increasing pension demands. Some 20 of the 36 municipal pension plans have funding ratios below 60%. These pressures resulted in the Chapter 9 bankruptcy of the City of Central Falls in 2011.

Now nearly five years later, several municipalities are considered to be distressed. For FY 2017, eight are determined to be eligible for funding from Rhode Island’s Distressed Communities Relief Fund. Pension requirements are but one of several criteria used to determine qualification for Fund monies. It is hoped that at least one community will be able to drop out of the program in FY 2017.

These factors are among many that weigh negatively on Rhode Island’s credit outlook as it continues to deal with the long-term decline of its major manufacturing industries. Its efforts to do so have been stymied by competition from the larger neighboring states in the region and larger and more established entities in those states in the commercial and service sectors that Rhode Island seeks to expand.

Our view is that those pressures will continue and will be sufficient to outweigh the impact of the positive steps which the State is undertaking. We would view that State’s debt as one to underweight versus other comparably rated state bonds.

PR CREDITOR AGREEMENT

According to press reports, the Government Development Bank (GDB) and a group of its creditors have struck a tentative deal, providing the bank with some relief ahead of its $422 million debt payment due May 2. The group of GDB creditors, which hold about a fourth of the bank’s roughly $4 billion debt, would agree to a forbearance agreement that covers only $120 million of the May payment. The government could still be pressed to declare a partial moratorium on the remainder of the payment, as there is not enough money to meet the payment in full. The tentative plan reportedly would also include a debt-exchange process whereby GDB creditors would get new with a haircut estimated at 50%. Creditors would have to accept that they would receive no principal payments in the next few years. The rest of the bank’s creditors would still need to join the agreement if the exchange is to take place.

Meanwhile in Washington, the Puerto Rico debt restructuring bill was still short of votes. The bill is still being rewritten, and as of yet the vote has not been rescheduled. The U.S. House Natural Resources Committee issued a statement Tuesday seeking support for its bill. “Congress cannot pass legislation to erase the decades of fiscal mismanagement and socialist policies that brought the territory to its knees. But a growing number of Members understand we must act on a responsible solution to prevent U.S. taxpayers from footing the bill,” the panel statement said.

Meanwhile, the situation on Puerto Rico remains “fluid”. The Puerto Rico House of Representatives passed a bill that would exclude general obligation (GO) and Sales Tax Financing Corp. (Cofina) bonds from the law that allows the governor to declare a debt moratorium. The leader of the PDP in the Senate said in an interview that he agrees that the government should not include general obligation debt or debt that is sustainable such as Cofina debt, which is guaranteed by the sales and use tax,  in the moratorium. He also said he believes the debt that was recently restructured at the Puerto Rico Electric Power Authority should not be part of the debt moratorium.
I don’t support including the general obligation bonds in the negotiation to restructure debt because it would be in violation of the constitution.”

However, Gov. Alejandro García Padilla immediately advised lawmakers in a statement that he plans to veto the bill if it reaches his desk. These maneuverings are why it is a fool’s errand for analysts to try to predict the outcome of this process. Those with the means and capacity to deal with these day to day machinations are most appropriately equipped to play in these bonds. Rare is the individual investor who is.

In the meantime, the Government Development Bank has filed with regulators to sell taxable debt that would mature May 2017 as officials negotiate with creditors about a $422 million payment owed at the start of May. And no, the Puerto Rican government has not released audited financial statements for FY 2014. They are requesting proposals from auditors for FY 2015 financial statements. And yes, it is FY 2017 that begins this July 1.

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

SEC STEPS UP MUNI FRAUD EFFORT

It will perhaps be of more interest locally in the NY metro area than nationally but the recent actions of the SEC enforcement staff in the municipal bond market should be encouraging to investors. The SEC alleges that Ramapo officials resorted to fraud to hide the strain in the town’s finances caused by the approximately $60 million cost to build a baseball stadium as well as the town’s declining sales and property tax revenues.  It is alleged that they cooked the books of the town’s primary operating fund to falsely depict positive balances between $1.4 million and $4.2 million during a six-year period when the town had actually accumulated balance deficits as high as nearly $14 million.  And because the stadium bonds issued by the Ramapo Local Development Corp. (RLDC) were guaranteed by the town, certain officials also masked an operating revenue shortfall at the RLDC and investors were unaware the town would likely need to subsidize those bond payments and further deplete its general fund.

According to the SEC’s complaint, inflated general fund balances were used in offering materials for 16 municipal bond offerings by Ramapo or the RLDC to investors, who consider the condition of a municipality’s general fund when making investment decisions.  After town supervisor Christopher P. St. Lawrence purposely misled a credit rating agency about the town’s general fund balance before certain bonds were rated, he told other town officials to refinance the short-term debt as fast as possible because “we’re going to all have to be magicians” to realize the purported financial results.

Christopher P. St. Lawrence, who served as RLDC’s president in addition to being town supervisor, masterminded the scheme to artificially inflate the balance of the general fund in financial statements for fiscal years 2009 to 2014. St. Lawrence and Aaron Troodler, a former RLDC executive director and assistant town attorney, concealed from investors that RLDC’s operating revenues were insufficient to cover debt service on bonds to finance the stadium. Troodler helped conceal the fictitious sale and boost the account balance of the town’s general fund by approving RLDC financial statements reflecting a purchase of property that never actually occurred.  Troodler also signed offering documents that contained an additional fabricated receivable totaling $3.66 million for another transfer of land from the town to the RLDC.  The only land transferred from the town to the RLDC during the time of the purported transaction was property donated for the baseball stadium, which St. Lawrence and Troodler knew did not impose any payment obligation on the RLDC.

Town attorney Michael Klein helped conceal outstanding liabilities related to the $3.08 million receivable recorded in the town’s general fund for the sale of a 13.7-acre parcel of land to the RLDC.  But because the title of the property was never transferred from the town to the RLDC, Klein also made misleading statements about the receivable’s source. Troodler helped conceal the fictitious sale and boost the account balance of the town’s general fund by approving RLDC financial statements reflecting a purchase of property that never actually occurred.  Troodler also signed offering documents that contained an additional fabricated receivable totaling $3.66 million for another transfer of land from the town to the RLDC.  The only land transferred from the town to the baseball stadium, which St. Lawrence and Troodler knew did not impose any payment obligation on the RLDC. The town’s deputy finance director Nathan Oberman participated in activities to inflate the town’s general fund by arranging $12.4 million in improper transfers from an ambulance fund to bolster the troubled general fund during a six-year period.

In a parallel action, the U.S. Attorney’s Office for the Southern District of New York today announced criminal charges against St. Lawrence and Troodler.

CONNECTICUT BUDGET WOES CONTINUE

Although by various measures, Connecticut is a wealthy state it’s budget is not immune from the pressures of declining revenues and accelerating expenses.   In part because  the state’s legislators are forced to rely heavily on its highest earners to fill the state’s coffers. Nearly 61% of tax revenues is from the income tax. They are  fearful of alienating more of the highest-earning residents after a tax increase last year. Since an initial budget was accepted in February, revenues have

To counter this trend, the Governor released a revised budget for FY 2017 that reflects a 4.89% decline in revenues from the February estimate. It employs layoffs of state employees to reduce expenses by 8.1%. This does result in a small surplus if nothing else changes. Connecticut is in a tough spot as it wealth is highly concentrated and much of it is mobile. On the expense side, flexibility is limited by the need to fund pensions after a long period of underfunding. Spending for those costs account for 5.6% of spending. In addition, debt service eats up a very high 12.8% of expenses.

So the outlook for Connecticut remains negative. This reflects the poor revenue trend and the maintenance of expenditure pressures going forward in an atmosphere of limited management  flexibility.

PUERTO RICO

Puerto Rico Secretary of State Víctor Suárez disclosed that discussions with a group of GDB creditors could involve a request for a forbearance agreement that would cover roughly $120 million of the May 2 payment due from GDB. “If we strike a forbearance agreement, there is still the possibility of declaring a partial moratorium,” said Suárez.  Suárez said it is not currently being contemplated that the creditor group would be asked for additional cash flow lending. He did acknowledge that “the cash flow situation of the government continues to be delicate. The government needs to follow up every week on its cash flow to make the calls with respect to the July 1 payments. It is very hard, very hard that the government can make any payment in July 1.

YOUTH SMOKING TRENDS

It’s the time of year when the states receive their annual payments from the tobacco companies under the Tobacco Settlement Agreement (TSA). As consumption of cigarettes (not other tobacco products) is one of the prime variables impacting the level of these payments  tobacco securitization bonds, annual trends in consumption are closely followed.

The Centers for Disease Control(CDC) and the U.S. Food and Drug Administration’s (FDA) Center for Tobacco Products in its Morbidity and Mortality Weekly Report (MMWR) showed that overall tobacco use by middle and high school students has not changed since 2011. Data from the 2015 National Youth Tobacco Survey show that 4.7 million middle and high school students were current users (at least once in the past 30 days) of a tobacco product in 2015, and more than 2.3 million of those students were current users of two or more tobacco products. Three million middle and high school students were current users of e-cigarettes in 2015, up from 2.46 million in 2014. Sixteen percent of high school and 5.3 percent of middle school students were current users of e-cigarettes in 2015, making e-cigarettes the most commonly used tobacco product among youth for the second consecutive year. During 2011 through 2015, e-cigarette use rose from 1.5 percent to 16.0 percent among high school students and from 0.6 percent to 5.3 percent among middle school students.

From 2011 through 2015, significant decreases in current cigarette smoking occurred among youth, but there was no significant change in the prevalence of current cigarette smoking among this group during 2014 – 2015. In 2015, 9.3 percent of high school students and 2.3 percent of middle school students reported current cigarette use, making cigarettes the second-most-used tobacco product among both middle and high school students. The importance of this particular data trend is that levels of youth smoking have a direct correlation to levels of adult smoking over the long term. Any change in this direction of this trend is noteworthy. This one, should it continue could slow or stabilize the overall decline in cigarette consumption which has negatively impacted levels of available revenues for the repayment of tobacco bonds in recent years.

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

PR BILL INTRODUCED

Rep. Sean Duffy, R-Wis., introduced a bill H.R. 4900, the “Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA).” late Tuesday to address Puerto Rico’s debt crisis. It was the subject of a Natural Resources Committee hearing on Wednesday and is expected to be voted on by the committee on Thursday. We outlined the expected basic provisions in our special edition of Tuesday April 12. The main changes in the bill since it was initially discussed are in the board’s makeup, its power to unilaterally impose regulations on the commonwealth, and the required steps for an entity to undergo restructuring. The board would still only be able to file restructuring petitions on behalf of the commonwealth and its public authorities after the debtors tried to reach an agreement with their creditors through voluntary debt restructuring proposals and have provided the board with up-to-date financial statements. The bill also eliminates a provision from the earlier version that gave the oversight board power to unilaterally implement recommendations and binding regulations.

Reaction from Puerto Rican politicians was mixed. Rep. Nydia Velazquez (D-NY) was unenthused. “Given that four Board members will be appointed by Republicans, there is significant reason to believe that restructuring authority will never be granted,” Velazquez said. “This concern is compounded by section 601, a new provision, which adds a collective action clause to the bill. This clause requires two-thirds of creditors to voluntarily agree to restructure their debt, a hurdle that is not realistically achievable.” In a conference call with journalists on Tuesday, Puerto Rico’s governor, Alejandro García Padilla, said he believed that Congress had taken Puerto Rico’s complaints of federal overreach seriously and acted in good faith to tailor the oversight board to Puerto Rico’s situation.

A hearing before the House Natural Resources Committee was held this week. The Obama administration expressed concerns that undermining the minimum wage and overtime rules in Puerto Rico, thereby increasing the disparities in pay between Puerto Rico and the mainland, is not a recipe for economic growth. Rather, it believes a locally administered Earned Income Tax Credit is a more powerful and effective way to stimulate the economy and encourage work. The one time mayor of Washington D.C., Anthony Williams commented on the issue of an oversight board. “The lessons drawn from other notable places that were subject to oversight does instruct that if done with due respect for those in public office, and with keen awareness of both community leadership and an eye on business interests, good and sustainable solutions can and have occurred.”

After the hearing, the Committee chairman said that the planned schedule for consideration of legislation needed to be extended. “The Administration is still negotiating on provisions of the legislation, creating uncertainty in both parties. This legislation needs bipartisan support, but Members need time to understand the complexity of the issue and the ramifications of any proposed changes. It is unfair to all Members to force a vote with provisions still being negotiated.”  In addition, As of Thursday, the PR government still did not know when the long-awaited Commonwealth Annual Financial Report (CAFR) for the year ended June 30, 2014, would be released.

The fiscal 2014 CAFR was due nearly a year ago, in May 2015. KPMG, the independent auditors tasked with the process, said it would take the firm another eight to nine weeks to complete the audit once they receive all pending information. Since early this year, administration officials have stated the government has handed in everything on their end. But they have also acknowledged that some commonwealth components have yet to finish certain processes related to the external audit, including the cash-strapped Government Development Bank (GDB) and two of the commonwealth’s retirement systems.

P3 UPDATE

The  I-69 Section 5 project is a part of an Indiana highway that is being expanded to handle expected increased truck traffic resulting from NAFTA. The I-69 Section 5 project involves rehabilitating and upgrading 21 miles of the existing four lane State Road 37 in Morgan and Monroe counties to interstate standards from Bloomington to just south of Martinsville, Indiana. As part of the conversion, the existing partially-controlled limited access facility will be upgraded to have fully controlled access and will include the addition of travel lanes in the north and southbound lanes.

Bonds have been issued secured by a pledge of future payments from the private entity which is constructing and will operate the road. Availability payment P3s transfer cost, schedule and quality risks away from taxpayers during such time that the private sector is responsible for construction, operations and maintenance. If the road isn’t made “available” to the public in compliance with performance standards in the contract, the recurring, inflation-adjusted payments are reduced accordingly. Under terms of the contract, the state would make an $80 million “down payment” to the private partner, Isolux Infrastructure, which would pay the $325 million estimated for construction. Once that section of highway is complete, the state starts paying the partner $21.8 million a year for 35 years and the company maintains the highway.

Fitch Ratings last week downgraded the Indiana Finance Authority’s private activity bonds (PABs) issued on behalf of I-69 Development Partners LLC (I-69 DP) for the I-69 Section 5 project to ‘BBB-‘ and placed the bonds on Rating Watch Negative. The downgrade reflects the deteriorating credit quality of Isolux Corsan SA (Isolux), parent of the construction contractor, Corsan-Corviam Construccion SA, whose rating was revised to ‘B-‘/Rating Watch Negative on Feb. 12, 2016. This followed an earlier downgrade of Isolux on Dec. 7, 2015 to ‘B’/Rating Watch Negative.

The downgrade further reflects a projected eight month delay to substantial completion, initially expected in October 2016, which was disclosed in the most recent construction update published in March 2016. The revised substantial completion date is now June 28, 2017. Now the bondholder is exposed not only to project risk but financial risk of the private construction contractor. There is a Debt Service Reserve Account sized at modest a six-month’s debt service.

P3 project s have not been quite the godsend that politicians and investors have hoped for in many cases. While the private entities are often better at project execution than government, they also have brought an element of financial risk to transactions often unrelated to the project at the center of an individual bond issue. The result has been a greater shift of risk to investors than they anticipated resulting a shift in the risk balance away from the issuers onto those investors.

BOND MARKET GETS SOME REGULATORY RELIEF

U.S. cities and states won a partial victory Friday as the Federal Reserve gave final approval to a rule that will allow banks to include some municipal bonds in allocations of easy-to-sell assets meant to serve as protection against a financial crisis. A multiagency rule adopted in 2014, called for the biggest banks to hold enough high-quality liquid assets to survive a 30-day period of financial stress. The central bank revisited the idea of including munis after local governments waged a lobbying campaign for the change.

Bank regulators adopted the minimum-liquidity demand as a response to deficiencies highlighted during the 2008 credit crisis, when financial firms were stuck with assets they couldn’t sell. The Fed, which announced completion of its revised rule in a statement, said it relied on an analysis that suggested certain munis should qualify because they have liquidity characteristics similar to assets such as corporate debt securities. The victory is only a partial one for issuers in that a substantial portion of muni activity occurs in the bank units overseen by the Office of the Comptroller of the Currency. So far, neither the OCC nor the Federal Deposit Insurance Corp. has matched the Fed’s confidence in the liquidity of the muni market.

The Fed’s change, which takes effect July 1, applies to Fed-supervised lenders subject to the liquidity coverage ratio requirement. Those bank holding companies will be able to include a limited slice of munis among the Treasuries, highly-rated corporate bonds and foreign-government debt they already count against their liquidity demands. The Fed will allow munis that “have a proven record as a reliable source of liquidity in repurchase or sales markets during a period of significant stress,” according to the text of the rule. Such munis can be part of a second tier of liquid assets, which can total no more than 40 percent of the overall liquidity buffer.

The phase-in period for the liquidity rule started in 2015 and it is set to go into full effect on Jan. 1. It’s also expected to be joined this year by a separate but related liquidity demand — known as the net stable funding ratio — that considers a longer stress horizon. Even under the pressure of rules and warnings from municipal lobbyists, banks have increased their muni holdings, which rose to almost $500 billion by the end of 2015, more than twice the levels the industry held at the end of the financial crisis.

SAN BERNARDINO PENSION BOND SETTLEMENT

Pension bonds have come in for lots of criticism as to whether or not they are a good tool for governments to use to deal with ballooning pension costs. Now there is another example of how they may not be such a good idea for investors either. Moody’s Investor Service said Monday  that San Bernardino’s bankruptcy settlement agreement with two pension obligation bondholders reached last week is a “significant loss and credit negative” for the bondholders and other investors in local government debt.

San Bernardino declared bankruptcy in 2012. The settlement includes a 60 percent haircut for the creditors, cutting the city’s payments to pension bondholders by $45 million. The California city agreed to pay a total of $51 million over 30 years, beginning one year after the bankruptcy court approves the city’s plan of adjustment. Although up significantly from the city’s original 1 percent proposal, Moody’s said its own calculations determined the public obligation bondholders would actually recover less than 30 percent of their investment, not the 40 percent stated in the settlement. Commerzbank Finance & Covered Bond S.A. and Ambac Assurance Corporation are the creditors of the city’s roughly $100 million in pension obligation bonds.

STADIUM BONDS NOT JUST A MAJOR LEAGUE ISSUE

The New York Yankees and the Tampa Sports Authority announced plans Monday for a $40 million improvement project at Steinbrenner Field, the Yankees spring training facility.  It would be financed equally among the State of Florida, Hillsborough County and the Yankees. The funding includes construction of new outfield concourses and gathering spots, improved access into the ballpark and additional improvements at the team’s minor league training complex nearby. The construction is expected to be complete by March 2017.

The Yankees will pay their portion of the construction through lease payments, which will run through 2046. Six teams have left Florida since 2003 to establish spring training homes in Arizona, making the Cactus League equal in size to the Grapefruit League. In response, the state passed a hotel tax that goes to fund new or renovated facilities. Exhibition games draw a greater percentage of out-of-town visitors than regular-season games in major league cities. So this may make more sense in support of the argument over whether these projects generate economic growth. The tax is paid by visitors, and that money is used to get a commitment from teams. The Yankees have already completed more than $6 million worth of renovations on the minor league and major league training facilities, including new batting cages.

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

NEW PLAN FROM PR

On Monday, Puerto Rico said it had found a way to make debt payments of $1.85 billion a year, compared with the $1.7 billion a year it had offered before. The new restructuring plan covers $49.3 billion of Puerto Rico’s total debt, most of which is in the form of municipal bonds. The larger margin is a result of using projected government revenue for fiscal year 2021, instead of fiscal 2016, as the basis for the restructuring team’s 15% debt-service target as a percentage of annual revenue.

It calls for creditors to exchange existing bonds for two new classes of bonds. The offer is up from a previous offer of $26.5 billion. Puerto Rico has taken the position that all types of creditors must sacrifice, however. The new offer announced on Monday reflects that position. General obligation bonds held by investors who do not live on the island would get a recovery rate of 74 percent under the new proposal. Holders of sales-tax-backed bonds would get 57 percent; and holders of bonds issued by the Government Development Bank would get just 36 percent.

The first type would be a “base bond” with a total face value ranging from $32.6 billion to $37.4 billion, depending on whether bondholders in Puerto Rico opted in or took advantage of the special offer available to them alone. The new base bonds would start out paying 1.1 percent interest for the coming fiscal year. (Under Puerto Rico’s previous offer, interest payments would not have started until a year later.) The interest rate would then rise gradually to 5 percent in 2021, the same year principal repayments would start. Bondholders living in Puerto Rico would, however, have the chance to recover more of their initial investment if they were willing to wait. Instead of trading in their holdings for the regular base bonds, they could opt for “local holder base bonds,” which would have a value equal to the face amount of the bonds being handed over. The local holder base bonds would pay a fixed, 2 percent rate of interest over a longer period of time.

For investors not living in Puerto Rico, there would be only a chance of getting a full recovery. In addition to their base bonds, they would get a second type, called “capital appreciation bonds,” which would not offer any cash payments until after the base bonds had been fully repaid and it was clear how much of a loss each type of bondholder had suffered. The CABs would be repaid in full upon maturity as they accrete value — at 5% annually over a 49-year period under the commonwealth’s most recent offer. CABs would ensure creditors fully recover initial losses, only if they hold onto these until maturity.

The higher recovery rates and a debt instrument tailored for local bondholders are the  major changes in the government’s revised debt-restructuring proposal, which was presented to creditors on March 23 before it was released publicly Monday. Negotiations between the commonwealth and its creditors are slated to continue this week. The commonwealth first proposed to creditors in January an exchange offer with two types of instruments: a mandatorily payable base bond; and a growth bond to be paid only if the island achieved economic recovery. Cuts to principal, or haircuts, hovered around 45%, and only $1.75 billion of government revenue would be available each year for debt service. This amount now increases to $1.85 billion, allowing the U.S. territory to offer more base bonds — and higher recovery rates — under the revised proposal. The larger margin is a result of using projected government revenue for fiscal year 2021, instead of  fiscal 2016, as the basis for the restructuring  team’s 15% debt-service target as a percentage of annual revenue.

Growth bonds would be replaced with capital appreciation bonds (CABs), which are repaid in full upon maturity as they accrete value — at 5% annually over a 49-year period under the commonwealth’s most recent offer. CABs would ensure creditors fully recover initial losses, only if they hold onto these until maturity. The commonwealth’s advisers believe this instrument will eventually become highly tradable as the island recovers its creditworthiness along the way.

Puerto Rico residents, who happen to mostly own the island’s less-secured debt, could now choose a par-for-par exchange, instead of taking discounted base bonds. These par bonds would mean a longer maturity for local bondholders, while receiving 2% interest payments for more than 50 years beginning in January 2017. Under the new offer, the amount of base bonds could reach as much as $27.8 billion, depending on the participation of Puerto Rico residents on the local instrument, while roughly $1.75 billion in CABs  and up to $8 billion in local holder bonds would also be issued. While seeking a leveled debt-service schedule, the commonwealth’s most recent offer would translate into a longer debt-repayment calendar. No principal payments until fiscal 2021 are still contemplated, but interest payments would now be paid current, scaling up until reaching 5% annually by fiscal 2021. The local bond option would always be paid a 2% annual interest during its life.

Proposed haircuts include about 16% for commonwealth-guaranteed debt, including general obligations (GOs), and 43% for Sales Tax Financing Corp. (Cofina) bonds. Less-secured paper, such as the Highways & Transportation Authority and the GDB’s, could see cuts to principal of 44% and 64%, respectively, while other credits end up in the 50% range. If the commonwealth fails to obtain a legal mechanism by which to bind holdouts or if the federal government significantly reduces financial support to the island, the terms of the exchange offer would have to be revised, which could mean larger haircuts for creditors.

At least three different creditor groups have countered with their own offers. These include constitutionally guaranteed GOs; sales tax-backed, lockbox-structured Cofina; and a group of local cooperatives and credit unions that mostly own less-secured paper.

For the administration, the creditors’ proposed fixes fell short, often solving only part of the problem and placing an unfair burden on less-protected credits. None of the counteroffers would deal with the government bank’s debt woes. None would contemplate cuts to principal.

So far, creditors have sought more government revenue dedicated to debt service, less impairment and higher recoveries. Commonwealth advisers recognize there is a tug of war over the administration’s 15% target of annual government revenues destined to debt service, and has said the idea is to make it the least painful possible to creditors.

PREPA

The passage of the debt moratorium legislation has created much uncertainty as to its impact on the existing agreement framework for a restructuring of Puerto Rico electric Power Authority’s outstanding debt. In a report issued late Friday, Moody’s weighed in with its opinion. “The moratorium law could also create complications for negotiations between the Puerto Rico Electric Power Authority (PREPA – Caa3/negative) and its lenders, which have been underway for 18 months and appear to be approaching a resolution. The law encompasses the commonwealth’s numerous debt-issuing entities including PREPA and gives Puerto Rico’s governor the power to invoke a state of emergency with respect to PREPA (or any other government agency), thereby beginning a moratorium. However, the law does not include the PREPA Revitalization Corp., the special purpose vehicle that is expected to issue securitization bonds to complete the restructuring of PREPA’s $9 billion of debt. We continue to believe that PREPA and its creditors are working constructively toward a consensual agreement.”

The next turn in the PREPA restructuring process will come when the utility will obtain a ruling on its securitization charges within the next 87 days, followed by a validation process. In parallel, PREPA’s restructuring team will be making its case before the credit rating agencies, which will ultimately decide if the new securitization bonds are worthy of investment grade.

AND IN CONGRESS

The House Natural Resources Committee had been expected to release a revised version of its Puerto Rico bill early this week, including a modification designed to avoid a constitutional challenge if the legislation is enacted. Some have warned the bill would violate the Uniformity Clause of the U.S. Constitution. That clause, in Article 1, Section 8, says, “Congress shall have power … to establish … uniform laws on the subject of bankruptcies throughout the United States.”

The bill would be revised to permit the other four U.S. territories, should their financial situations plummet, to opt into its provisions. The territory’s Governors would have to sign them. As a result, Guam, the U.S. Virgin Islands, America Samoa, and the Northern Mariana Islands could opt for the creation of an oversight board that would have the sole ability to file a petition for debt restructuring.

Under the bill, debtors could not have a proposed financial control board file a petition for restructuring on their behalf until they have released their most recent audited financial report and engaged in voluntary debt restructuring discussions with creditors. The bill borrows from Chapter 9 of the U.S. Bankruptcy Code but explicitly avoids amending that statute and instead uses the Territorial Clause of the Constitution as the basis for its debt restructuring provisions. The other territories don’t want to be in the measure.

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

PR GDB UNDER PRESSURE FROM CREDITORS

A group of hedge funds asked a federal court in San Juan on Monday to freeze the assets of Puerto Rico’s Government Development Bank, claiming it was insolvent and appeared to be spending what cash it had left to prop up other parts of the island’s troubled government. The bank had failed to provide financial information that creditors were entitled to under federal law, the hedge funds said in a lawsuit. They asked the United States District Court in San Juan to bar further cash transfers by the bank, other than those essential to the safety and well-being of the island’s residents.

“Once G.D.B. spends its last remaining funds — and it is only a matter of time — many essential services in Puerto Rico may come to a halt,” the hedge funds said in their complaint. By then, they said, there would be nothing left for the bank’s creditors, who “will suffer substantial losses.” The Government Development Bank has a debt payment of about $422 million due on May 1. It is doubtful as to whether the bank has enough cash to make it.

The president of the bank, Melba Acosta Febo, responded that the lawsuit’s accusations were “erroneous” and that the bank was acting within the bounds of the relevant laws. “The central claim of G.D.B.’s creditors, that G.D.B. has knowingly withheld financial information in order to prefer certain depositors over its bondholders, is wholly false and without basis in fact,” she said, adding that the bank “will respond to the complaint in full through proper legal means.”

PR THROWS A TANTRUM

The Governor signed the Puerto Rico Emergency Moratorium & Financial Rehabilitation Act. It empowers the governor to order the Government Development Bank (GDB) to restrict the outflow of cash in a bid to stabilize its dwindling liquidity levels, which stood at roughly $560 million as of April 1, according to the bill. Initial plans called for having García Padilla signing an executive order to this effect immediately following the enactment of the moratorium legislation. The House passed, without alterations, the version the Senate approved the night before. Representatives passed the bill after House Treasury Committee Chairman Rep. Rafael Hernández gave up on attempts to take out the general obligation (GOs) debt from the governor’s moratorium.

The sudden moves seemed likely to make more difficult the effort in Washington to enact a rescue package for Puerto Rico. The House Natural Resources Committee, which has been drafting the rescue in consultation with Democrats in Congress and the Treasury Department, released a statement as we went to press. House Committee on Natural Resources Chairman Rob Bishop said “efforts to refine the Committee’s discussion draft continue. All parties are working in good faith as we finalize responsible legislation that helps solve the crisis and protects American taxpayers. “I thank Speaker Ryan for allowing an open process with input from all stakeholders. The input we have received has been wonderful and positive; it will make a better bill. I thank all Members and stakeholders for their engagement in this process.”

The drafters have been trying to strike a balance between Democratic and Republican Party priorities as well as numerous constitutional hurdles. So far, the lawmakers in Congress have called for sending a federal oversight board to Puerto Rico, auditing all major branches of government there, promoting fiscal reforms and eventually providing certain restructuring tools that are normally available only in bankruptcy. But the oversight board, which may have seemed a reasonable requirement in Washington, is still seen on the island as an intolerable vestige of colonial rule.

ATLANTIC CITY APPROACHES THE EDGE

Gov. Chris Christie announced Monday that the state is suing Atlantic City to make sure the local government pays $34 million it owes to the city’s school district over the next few months, once again escalating a bitter battle over the ailing finances of the gambling resort. In a Statehouse news conference on Atlantic City, Christie accused city officials of using the money to stay afloat and “fund rich union contracts they’ve been unwilling to change.” At issue is state law that requires municipalities across New Jersey to collect property tax payments on behalf of their school districts and give that money to them in scheduled payments.

Christie said Atlantic City’s municipal government has about $10 million left and is neglecting the next payment to make a city payroll of $3.2 million Friday. Today he called the mayor a liar who has “zero idea” what he’s doing. The lawsuit seeks to compel the city to make the payments owed from now until June, beginning with an $8.4 million installment on April 15. In his own news conference at the Statehouse on Monday, Atlantic City Mayor Don Guardian said the city is on a payment schedule set by a state monitor and that the city always intended to make the upcoming payments. Mayor Guardian also announced that Atlantic City’s nine public-worker unions have agreed to a plan to stretch payroll payments from 14 to 28 days to avoid a city shutdown that was set to begin Friday. The city council was expected to finalize the plan as we go to press.

The lawsuit could put added pressure on state Assembly Speaker Vincent Prieto (D-Hudson) to break an ongoing standoff with the Governor and allow a vote on legislation that would authorize a state takeover of Atlantic City’s local government. Christie has said he will sign a state aid package for the city only if state lawmakers pass legislation approving the takeover. He will only sign the aid package and the takeover if they are passed together, without any changes. Prieto has said that the bill has no chance of passage in its current form.

There are a myriad of ways in which the political structure in Atlantic City can be criticized for decades of corruption and failure. In no way does it provide the Governor for a basis to act in ways which are so counterproductive and which bring into question the State’s long standing willingness to protect holders of local debt issued by the State’s municipalities. The Governor’s rants do not provide a basis for a positive resolution.

STADIUM FINANCING A TARGET AGAIN

In a time when the simplest of issues can be made extremely complex, it is nice to see a piece of legislation introduced that makes no effort to disguise its purpose. Rep. Steve Russell, R-Okla., has introduced a bill in the House that would prohibit the use of tax-exempt bonds to build or subsidize professional sports stadiums and for-profit entertainment arenas. It is simply titled the “No Tax Subsidies for Stadiums Act”. Under current law, a stadium can be built with tax-exempt bonds as long as no more than 10% percent of the debt service is paid or secured by private parties and no more than 10% of it is privately used. Since 2006, 263 tax-exempt bond issues totaling $16.9 billion have been sold to finance stadiums and sports arenas, according to figures compiled by Thomson Reuters (TRI). That includes the five bond issues totaling $82.2 million have been reported thus far for 2016.

The bill states in plain English that “Section 103(a) shall not apply to any bond issued as part of an issue any proceeds of which are to be used to provide a professional entertainment facility. For purposes of this subsection, the term ‘professional entertainment facility’ means any facility (and appurtenant real property) which, during at least 5 days during any calendar year, is used as a stadium or arena for professional sports exhibitions, games, or training, or as a venue for any entertainment event the live audience for which exceeds 100 individuals, and any net earnings from which inure to the benefit of an individual or any entity other than the United States, any State or political subdivision thereof, any possession of the United States, or any agency or instrumentality of any of the foregoing, or an organization which is described in paragraph (3), (4), (5), (6), (7), (10), (19), or (23) of section 501(c) and exempt from tax under section 501(a) or is a political organization (as defined in section 527(e)(1)).”.

The amendment shall apply to obligations issued after the date of the enactment of the Act. In a statement, Russell said the Office of Management and Budget has estimated that repealing tax-exempt bond financing for stadiums would lower the budget deficit by a total of $542 million over the next decade. Russell, who serves on the House Armed Services Committee and is a retired career military man, said that money could be used to fund the armed services. He is a first term Congressman who is a disciple of former Senator Tom Coburn who espoused strict limits on federal spending which he was often unsuccessful in achieving.

We think that the impact on investors would be minimal. The more likely aggrieved parties would be the teams that use the facilities and the bankers who structure and underwrite the deals.

CHICAGO PUBLIC SCHOOL DEBT – INVESTMENT OR WAGER?

The impact a Chapter 9 bankruptcy would have on Chicago Public Schools and its investors is uncertain at best. The district in its most recent bond sale declared that one of its pledged repayment streams under the state’s alternate revenue bond structure would meet the bankruptcy code’s designation of “special revenues” that are largely shielded in Chapter 9.

CPS’ most recent bond issue was accompanied by a special opinion that provides the legal reasoning behind CPS’ position that the bonds’ structure provides a security which preserves the statutory lien on pledged revenues and offers relief from the automatic stay provisions of the bankruptcy code. Whether it would hold up in bankruptcy court given the limited litigated precedent, it would be a contested issue with no guaranteed outcome.

The bonds are full faith and credit obligations supported by a pledge of property tax revenues of the CPS. The pledged tax revenues are levied as part of the bond resolution but are abated by the district because it uses pledged state aid to cover debt service. Abatement comes only after CPS makes its annual February deposit into the debt service account to cover June and December payments with state aid or some other revenue, if necessary. The tax levy for debt service has never been triggered.

The structure allows non-home rule governments like CPS to get around voter approval requirements. The backdoor referendum model requires a public vote only if sufficient signatures are raised after CPS publishes its intent to issue the bonds. No opinion has been offered as to how pledged state aid would be treated because those funds are comingled with other revenues and so would not meet bankruptcy code’s definition of special, segregated revenues. The board acknowledges there is no binding legal precedent for its position and doesn’t guarantee the debt would avoid a cram down where the pledged tax revenue could be stayed and terms adjusted in a plan of adjustment deemed “fair and equitable” by the court.

There is limited precedent in Illinois on which investors can rely. Some feel that an Illinois appellate court that upheld an alternate revenue structure and tax pledge in a 2002 case involving a hospital that had closed provides guidance. A Chapter 9 filing is currently not possible under Illinois law, and CPS is exempt from some state oversight rules.

The school board is authorized to direct the county to deposit pledged property taxes with the trustee but that direction can be revoked. If CPS is correct about the way its bonds would be treated in a bankruptcy, such a Chapter 9 outcome would leave pensions and contracts to take the hit. That runs in the face of the fact that public pension benefits enjoy strong protections under the state constitution – a status that was reinforced by the Illinois Supreme Court’s ruling last week that benefit cuts in Chicago’s 2014 pension reforms violate state law giving contractual status to membership in governmental pension funds.

In the end, the bonds provide enough uncertainty in our view as to place them in the category of a wager, albeit one supported by an annual 8.75% interest payment pledge.

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

PENNSYLVANIA BUDGET IMPASSE ENDS WITH A WHIMPER

After nearly nine months, Pennsylvania’s state budget impasse ground to an end Wednesday, with Gov. Tom Wolf saying he would allow a Republican-crafted appropriations bill to become law without his signature. Mr. Wolf  said he believes the budget is not balanced, but that by releasing the approximately $6 billion in state funding without his signature, schools will be able to stay open through the end of the year. Mr. Wolf, who has pressed for tax increases to boost education funding and close a structural deficit, made clear he does not believe the final appropriations bill is properly funded. “The money it claims to provide really doesn’t exist,” he said.

The appropriations bill became law at 12:01 a.m. Monday, after Mr. Wolf refrained from acting on it through Sunday, his office said, completing a budget of about $30 billion. The governor and legislative leaders said work on the next state budget, for the year that begins July 1, will start next week. To get through the first half of the year, before they received state money, school districts and the intermediate units that provide them services borrowed about $1 billion, incurring $40 million to $50 million in interest and fees, according to state Auditor General Eugene DePasquale.

But for all the relief that will be felt by school districts  there was little evidence that the governor and legislators are closer to resolving the differences that dragged this year’s state budget nearly three-quarters of a year past its June 30 deadline. House and Senate Republican leaders plan to continue resisting tax increases and pushing for changes to the retirement system for state and public school workers and to the system of wine and liquor sales.

Mr. Wolf said he would also allow bills to deliver state money to the state-related universities, which include the University of Pittsburgh and Penn State University, to become law without his signature. But he said he would veto the fiscal code, a bill that implements the budget. The governor’s spokesman said there were numerous problems with the fiscal code, including what he called intrusion into the authority of the executive.

The appropriations bill that became law Monday delivers more than $3 billion in additional money for the main K-12 education funding line, combining with the funding approved in December to total an increase of $150 million from the previous year. Providers of human  debt service incurred because of the impasse for years, and that nonprofits are concerned the politics of the 2016 election year will cause another budget delay.

So what was the point?  The state system of funding education remains heavily dependent upon rising and unpopular local proper taxes. The natural gas bounty underneath the Commonwealth remains relatively immune from direct production or severance taxes. The pension and liquor store issues remain unsatisfactorily addressed. This leads to continuation in the decline of the Commonwealth’s credit metrics and the loss of an additional year of potential benefit to the Commonwealth from an improved economy. It is a lose/lose all around with the outlook being for more of the same through the fall election period.

PRIDE GOETH BEFORE THE FALL

We’ve  been pretty consistent in our view that the Puerto Rican government is its own worst enemy as its debt crisis unfolds. The reaction to a draft of legislation that would give PR 18 months of debt relief and a right to impose a cramdown on debt holders, in exchange for outside oversight was met with childish contempt. The consistent role of pride on the part of the island’s politicians in the face of continuing corruption, incompetence, and inadequate financial disclosure continues to erode the willingness of creditors and legislators to assist the Commonwealth government. What was good enough for Washington, D.C., Philadelphia, and New York is apparently too much of an adult concept for PR to grasp.

The federal legislation that would impose a federal oversight board for Puerto Rico is expected to be introduced April 11, followed by a hearing two days later. The legislation would create a five-member federal control board that would be empowered to balance budgets, securitize revenue, guarantee payment and hold accounts for future commonwealth bond issuances, as well as provide a restructuring mechanism outside the bankruptcy law. Island lawmakers would be required to approve a budget in which expenditures are in line with revenues, and if that does not happen, the board would have the power to balance the budget for them.

Another example occurred this week when a federal judge in San Juan on Monday threw out a new tax that Puerto Rico had tried to impose on the American retailing giant Walmart, calling it unlawful. Walmart had argued that the new tax would confiscate more than 100 percent of its profit from operations in Puerto Rico. The judge, José Antonio Fusté of the United States District Court in Puerto Rico, said in his opinion on Monday that it gave him no pleasure to throw out the tax, considering the commonwealth’s dire financial condition. said it was unlawful and that Puerto Rico’s crisis was not an excuse “to take revenue that it’s not entitled to, to pay for essential services.” The new tax was more than triple the old rate, he said, “designed to capture Walmart Puerto Rico, the biggest fish in the pond.” If Walmart paid it on time, and waited to get a refund through the usual channels, it would most likely never see the money again, he added.

Walmart  is Puerto Rico’s largest employer outside the government and is also the island’s biggest remitter of tax revenue. Comprising Walmart Supercenters, Walmart Discount Stores, Supermercados Amigo, Sam’s Clubs, and, until earlier this year, Super Ahorros, it operates 48 stores on the island, employing some 14,300 residents. Each store employee receives a minimum wage of at least $10 an hour, $2.75 higher than the minimum wage set by law in Puerto Rico. Wal-Mart Puerto Rico sells about $3 billion worth of merchandise each year and remits more sales tax to the commonwealth than any other retailer. It buys around $1.6 billion in inventory from local vendors and suppliers each year. About $15 billion of Puerto Rico’s outstanding debt is backed by a dedicated sales tax that Walmart helps to collect.

The company did not explicitly threaten to leave Puerto Rico if it did not prevail, but it did argue in court that no business could operate for long in a place that confiscated all of its profit.

VICTORY FOR PUBLIC SECTOR UNIONS

The Supreme Court announced that it had reached no decision, meaning that the judgment of a lower court below was affirmed in Friedrichs v. California Teachers Association. The case was an appeal filed by nonunion public sector workers who objected to paying fees to unions basically for collective bargaining efforts taken on their behalf. The requirement has been a target for conservative politicians for quite a while.

This is the first case the court has handed down in which Justice Antonin Scalia’s death last month has seriously impacted the legal landscape. When the case was argued earlier this year it seemed clear that the five conservative justices on the court were extremely receptive to an argument that would have effectively crippled unions across the land. California, along with 22 other states, requires all public employees represented by unions to pay a “fair-share” or “agency” fee, which is directed toward the union’s collective-bargaining activities, even if they do not belong to the unions. This has been approved by the Supreme Court for nearly 40 years and allows those who benefit from union activities to opt out of a union’s political efforts without being free riders. The arrangement was challenged by ten California teachers as an unconstitutional form of compelled speech.

The ruling means that union agency shop fees in the public sector are still constitutional, for now. Petitioners’ counsel has already announced, though, that they intend to seek a rehearing next term by the full court.

OREGON POT TAXES ARE A BETTER HIGH THAN EXPECTED

Oregon has offered the first look at how much pot is moving through the state’s newly regulated retail market. It announced that it had collected $3.48 million in taxes from recreational marijuana sales in January, far outpacing estimates. Oregon dispensaries sold at least $14 million worth of recreational marijuana in January alone. That figure doesn’t take into account medical marijuana sales, which remain untaxed.

The collections for a single month exceed state economists’ projections for the entire year. Officials expected between $2 million to $3 million after the state paid for the costs associated with regulation. A senior economist with Oregon’s Legislative Revenue Office, called the first round of marijuana tax collections “healthy,” but cautioned that sales may fluctuate as will the tax rate. The state also hasn’t calculated the expense of regulating the new market.

The Oregon Department of Revenue said it collected the January taxes from 253 dispensaries between Feb. 1 and March 4. The number of dispensaries that paid the tax is lower than the 309 registered with the Oregon Health Authority. The Revenue Department is contacting dispensaries that didn’t make a tax payment to “make sure they are aware of the requirement to file and pay,”.

Some may have only sold medical marijuana in January even though they’re listed on the health authority’s directory as selling recreational pot. The health authority regulates medical marijuana dispensaries. Oregon’s medical marijuana stores have been allowed to sell a limited amount of cannabis flowers, as well as starter marijuana plants and seeds, to anyone 21 and older since last October. The state’s temporary 25 percent tax didn’t kick in until Jan. 1. That tax will eventually be replaced with one ranging from 17 percent to 20 percent once the Oregon Liquor Control Commission assumes control over recreational marijuana sales later this year. The Legislature set the base tax rate at 17 percent, but cities and counties may adopt ordinances that add up to 3 percent more.

Next year, the first full year of sales under the liquor commission, state economists project recreational cannabis sales to generate $10.75 million in tax revenue after the state covers startup costs. That number is expected to climb to $62.42 million for the 2017-2019 biennium. Dispensaries are required to file a tax return every quarter, but they must make payments each month. The monthly payment requirement stems from concerns about dispensaries keeping too much cash on hand. Dispensaries that don’t pay their taxes face the same penalty as other delinquent taxpayers: 5 percent of what they owe would be tacked onto their bill. By law, dispensaries are allowed to keep 2 percent of the tax to offset the costs related to collection. The Revenue Department also keeps some to cover the cost of administering the tax. The liquor commission, too, gets some to pay for the expense of regulating the market.

After that, the law says 40 percent goes to thestate’s Common School Fund, 20 percent to mental health, alcoholism and drug services, 15 percent to Oregon State Police, 10 percent for city law enforcement, 10 percent for county law enforcement and 5 percent to the Oregon Health Authority for alcohol and drug abuse prevention, early intervention and treatment services. The 19 counties and 80 cities that have opted out of recreational marijuana sales don’t get a share of the tax revenue.

PENSIONS STILL AN ISSUE IN SPITE OF ALL THE ALARM

Moody’s Investors Service  has released its findings from a recent survey of public pension plan funding. It used available fiscal 2015 accounting disclosures of 56 public plans and found that recent market volatility has negatively affected the asset performance of several large US pension plans, and could be an early signal that fiscal 2016 returns will fall short of assumed targets for the second consecutive year and erase funding improvements seen in FY 2013 and 2014.

Moody’s projects unfunded pension liabilities on a reported basis will grow by at least 10% in fiscal 2016 under even its most optimistic return scenario. It also projects an alternate scenario of negative 10% returns where a 59% increase in reported-basis unfunded liabilities are estimated. Moody’s adjusted net pension liabilities (ANPLs) will grow up to 29% under the same return scenarios.

Moody’s also found that 55% of pension plans in its sample are not receiving contributions from state or local governments that cover current benefit accruals and interest on existing unfunded liabilities. That, combined with poor investment performance, will make pension plan liabilities even larger. It estimates that unfunded pension liabilities could reach a four-year high relative to payroll in all but the most optimistic scenario.

Exposure to market volatility across public plans varies widely among individual states and local governments. While unfunded pension liability growth is anticipated in 2016, the capacity of individual governments to absorb increasing pension costs depends on revenue growth and the ability to control other expenditures.

The sample comprises slightly more than half of all public defined benefit pension assets and mostly includes plans with June 30 fiscal year-ends. The finding bodes poorly for credits like Illinois, Chicago, Pennsylvania, New Jersey, and Connecticut just to name a few. It means that even more aggressive must be taken in the form of funding from current contributions if the funding gap is to be reduced.

NYC BUDGET OUTLOOK

The Independent Budget Office expects the city will end the current fiscal year with a surplus of $2.5 billion, $216 million more than the de Blasio Administration’s estimate. It projects the city will end 2017 with a surplus of $490 million; projections for the subsequent years of the financial plan find relatively modest shortfalls of less than $2 billion a year, budget gaps that are very small relative to city– generated revenues and could be substantially offset with funds currently held as general reserves. Of the nearly $2.0 billion in growth it projects in tax revenues in fiscal year 2017, $1.6 billion is expected to come from increased property tax collections. By 2020, it estimates that property taxes will account for 46 percent of the city’s tax revenues—in 2008, when income and property transfer taxes peaked, the property tax comprised 35 percent of city tax revenues.

In calendar 2014 and 2015 the city added more than 100,000 jobs annually, IBO projects the job gain will dip to about 77,500 this year. The number of new jobs is expected to fall even further in 2017 through 2020, averaging about 50,000 annually. Jobs in professional and business services and in health care services are expected to together account for about half the new jobs created in the city during the forecast period. Despite the strong dollar and overseas economic turbulence, it is anticipated tourism will remain an important driver of the local economy. As in the recent past, Wall Street’s role in fueling the city’s economy will continue to be diminished.

Tax revenues are projected to increase by $2.0 billion in fiscal year 2017 to reach $54.9 billion, $603 million more than the de Blasio Administration’s estimate. Over the 2016-2020 forecast period, it is projected tax revenues will increase at an average annual rate of 4.5 percent, rising from $52.9 billion in 2016 to $63.0 billion in 2020. New expenditure is needed to increase the city’s pension contribution by about $600 million annually beginning this year and through 2020. The additional city contribution results from actuarial changes such as estimates that retired city employees are living longer and therefore receiving pension payments for more years than in past projections. Spending on pensions for the municipal workforce is now expected to increase by a total of about $800 million over the financial plan period, growing from $9.3 billion in 2016 to $10.1 billion in 2020, an average annual increase of 2.0 percent.

Debt service is expected to grow from $6.3 billion this year to $8.1 billion in 2020, an annual average increase of 6.5 percent after adjusting for the use of budget surpluses to make prepayments.

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 TAKES ANOTHER CREDIT HIT

Already facing a short term pension crisis, the City of Chicago suffered a severe body blow today when the Illinois  found unconstitutional a law that sought to cut benefits and require employees to pay more toward their retirement. The state’s high court agreed with a Cook County judge who found that the state law that Mayor Rahm Emanuel pushed through in 2014 violated a clause in the Illinois Constitution that states pension benefits once granted “shall not be diminished or impaired.” “These modifications to pension benefits unquestionably diminish the value of the retirement annuities the members of (the city workers and laborers funds) were promised when they joined the pension system. Accordingly, based on the plain language of the act, these annuity reducing provisions contravene the pension protection clause’s absolute prohibition against diminishment of pension benefits, and exceed the General Assembly’s authority,” the justices wrote in their opinion.

Losing the case frees up some money in the short term because the Emanuel administration won’t have to pay as much money into the two pension funds for non-uniformed municipal workers and laborers. But for the police and firemen’s funds a looming year-end budget shortfall has forced Mayor Rahm Emanuel’s administration to borrow $220 million in yet another sign of the city’s precarious pension funding status. The city drew the money down from its $900 million line of short-term credit, which carries an interest rate of about 3 percent. The money is not due to police and fire pension funds until the end of the year. But the city had to borrow the money to meet a March 1 deadline for having the cash in its treasury. State law requires that the city deposit the money with the treasurer to demonstrate it has the money available if it’s needed. The city doesn’t expect to raise enough from property taxes so, it must deposit the anticipated shortfall by March 1.

The City Council voted in October to increase property taxes by $543 million annually in phases over four years, with nearly all of the money dedicated to police and fire pension fund contributions. But that budget still depended on Gov. Bruce Rauner to sign a bill that would stretch out the payments and reduce this year’s cost by $219 million. Although the state House and Senate, both controlled by Democrats, approved the bill, they have not sent it to the governor for fear he’ll veto it if they don’t sign on to his pro-business, union-weakening agenda. The governor’s spokesman has said Rauner would sign the bill only “as part of a larger package of structural reform bills.”

That argument has been keeping the state from approving a budget for more than eight months now. And there’s no end in sight to that stalemate, given that last week’s primary elections did not change the state’s partisan political landscape despite the record amounts of money spent on some General Assembly contests. If the governor signs the bill, the city will return the $220 million to its line of credit. If not, it goes to the police and fire pension funds at the end of the year. If the bill isn’t signed, the city will have to pay off the $220 million loan. That could mean service cuts, further tax increases or both. Some political observers believe the Springfield logjam could break after the November general election. But if the Chicago police and fire pension bill is not signed by Rauner, the city could end up more than $1.2 billion short over the next five years.

An additional negative concern is that leaders of one pension fund think the city has to pay up well before the end of the year. The Firemen’s Annuity and Benefit Fund of Chicago board last week voted to notify city Treasurer Kurt Summers that it expects the city to remit $47 million — its share of the $220 million — to the pension fund within 31 days of depositing the borrowed cash. The police and fire retirement fund shortfalls aren’t the city’s only pension concerns. If the court upholds the trial court determination that the law is unconstitutional, the city would no longer be obligated to make the increased contributions, but the shortfall would continue to grow — meaning the city would have to pay more over the long haul. That could ultimately mean even higher property taxes.

PR SHOWS ITS HAND

Seven-members of the Supreme Court (Justice Samuel Alito recused himself from the case because of a financial conflict and no one has yet replaced the late Justice Antonio Scalia) heard arguments urging them to overturn a ruling last year by the U.S. Court of Appeals for the First Circuit in Boston, that concluded the Puerto Rico Public Corporation Debt Enforcement and Recovery Act (DERA) is illegal. The appeals court sided with funds that hold over $2 billion of bonds by the Puerto Rico Electric Power Authority and concluded that DERA violates a section of the U.S. Bankruptcy Code that prohibits states from passing laws allowing their authorities to restructure debt without the approval of those entities’ creditors. The  high court is expected to rule on the case by June.

But even if four of the seven Justices rule in favor of Puerto Rico and overturn DERA, several of them seemed to be concerned that DERA might violate the contract clause of the U. S. Constitution, which prohibits states from impairing private contracts. The lawyer for the Commonwealth told judges the contract clause issue could be argued if the case is remanded back to the appeals court, but it is not an issue before the high court.

Congress could eventually pass legislation that either gives, or refuses to give, Puerto Rico or its authorities bankruptcy protection under Chapter 9 and that measure would supersede any ruling by the Supreme Court.

During oral arguments the lawyer representing hedge fund BlueMountain Capital Management as well as Franklin and Oppenheimer funds was asked, “Why would Congress put Puerto Rico in this never-never land, that is, it can’t use Chapter 9 and it can’t use a Puerto Rico substitute for Chapter 9?” Puerto Rico “is locked out … It has to take the bitter but it doesn’t get any benefit at all,” she said. Justice Sonia Sotomayer, said, “It is inherent in state sovereignty that states have to have some method, their own method, of controlling their municipalities.”

The Commonwealth’s attorney argued that two sections of Chapter 1 of the bankruptcy code serve as a “gateway” that keeps Puerto Rico out of Chapter 9 altogether, including Section 903(1) which says state law cannot prescribe “a composition of indebtedness” that bind creditors without their consent. Section 101(52) of the code says in part that the definition of state “includes the District of Columbia and Puerto Rico” except for the purposes of defining who may be a debtor under Chapter 9.”

Section 109(c)(2) of the code says an entity is only a debtor under Chapter 9 if it “is specifically authorized, in its capacity as a municipality or by name, to be a debtor under such chapter by State law, or by a governmental officer or organization empowered by State law to authorize such entity to be a debtor under such chapter.” The Commonwealth feels that section means Puerto Rico is categorically precluded from authorizing its municipalities to enter Chapter 9 and that it is simply not part of Chapter 9.

The justices noted that the bankruptcy code does not mention Guam or the Virgin Islands and wondered if Congress intended to treat the territories differently. (The Menendez legislation does.) Roberts asked why it doesn’t make sense to think Congress wanted to keep Chapter 9 for the states and make the territory come to it for help. In response to the argument that it would be very anomalous [for] Puerto Rico [to be] in a worse position, let’s say, than Guam and the Virgin Islands, Roberts asked why did Congress lump Puerto Rico with the District of Columbia in saying in the bankruptcy code that there were not states except for the purpose of defining who would be a debtor under Chapter 9.

Ginsburg also asked the hedge funds’ lawyer, “What explains Congress wanting to put Puerto Rico in this anomalous position of not being able to restructure its debts?” His answer was that Congress has always micro-managed Puerto Rico’s debt, citing a change to the Jones Act aid that limited the amount of debt it could take on. Second, he said, Puerto Rico debt is triple tax-free and therefore is held by bondholders all over the U.S. Finally, he noted, when Congress amended the bankruptcy code in 1984 to say Puerto Rico is a state except for defining who a debtor is under Chapter 9, it was concerned about the amount of indebtedness of both Puerto Rico and D.C.

The real strategy of the current PR administration was reinforced after the hearing. Resident Commissioner Pedro Pierluisi said “it continues to be my view that the most responsible course of action is not to wait for the Court to rule, but rather for Congress to swiftly enact legislation that, on the one hand, authorizes Puerto Rico to restructure a meaningful portion of its debt and, on the other hand, establishes a temporary and independent board that enables the Puerto Rico government to engage in more disciplined fiscal policymaking, to publish transparent and timely financial information, and to regain access to the credit markets on reasonable terms. The board can also between debt-issuing entities and their creditors and serving as a gatekeeper before any debt-issuing entity can ask a federal judge to make a restructuring agreement  binding on all creditors.”

FERTILIZER PLANT FAILS TO YIELD A GOOD CREDIT

Back in 2012, over $1 billion bonds were issued by the Iowa Finance Authority under its Midwestern Disaster Area Revenue Bond program on behalf of the Iowa Fertilizer Company. Iowa Fertilizer was a subsidiary of an Egyptian based production company. At the time, the issue generated much controversy due to the foreign ownership of the Company and its use of materials that were considered to be useful to terrorists. The plant was also being built shortly after a massive explosion at a Texas fertilizer production facility had occurred. Many questions were raised as to the appropriateness of the use of tax exempt financing in such a large amount for such a foreign owned project.

That facility is back in the news for more traditional high yield market reasons. The company behind a $1.9 billion fertilizer plant under construction in southeast Iowa stopped making payments and held on to tools of one of the project’s contractors, according to a lawsuit filed in U.S. District Court. In the lawsuit, the contractor claims Orascom E&C USA hired the company to work as a subcontractor on the fertilizer plant. The company claims Orascom E&C paid it for its work up until September 2015.

According to the suit, after that date Orascom E&C stopped making payments. Maintenance Enterprises says Orascom E&C has made no payments regarding certain work since Oct. 29, 2015. Overall, Maintenance claims Orascom E&C owes it more than $53.4 million. Maintenance also claims Orascom E&C “physically barred” the company from removing small tools, protection equipment and other property Maintenance says it purchased for use on the plant. Maintenance has filed a mechanic’s lien with the Iowa Secretary of State’s office against the Iowa Fertilizer property for more than $50 million. It is not the only company to issue a mechanic’s lien on the property.  Other liens include one for more than $119 million filed by Texas-based RW Constructors. Liens for millions of dollars each have also been filed by companies based in Iowa, Illinois and Washington.

Now the bond trustee has informed holders of the bonds that the commissioning of the plant has been delayed due to construction delays. The EPC Contractor is revising the Mechanical Completion and Provisional Acceptance dates. This has resulted in the Company incurring additional administrative costs during the delay period. In order to complete the project, the Company will need to rely on funds outside of the Committed Funds, as defined in the Collateral Agency Agreement, such as profits from production earned prior to Provisional Acceptance, cash deposits by customers on fall prepay sales customary for the Midwest fertilizer market, and potentially support from its parent. OCI N.V., the ultimate parent of the Company remains committed to completing the project.

The Company is required to provide notice within ten business days that it filed a Requisition with the Collateral Agent in accordance with the Collateral Agency Agreement. The Company filed such a Requisition on February 22, 2016, which will be disbursed from the Equity Construction Account in accordance with the provisions of the Collateral Agency Agreement. The Company did not satisfy the requirement of the Collateral Agency Agreement, providing for a certification by the Company on each requisition that Provisional Acceptance  can be achieved by the Scheduled Provisional Acceptance Date. The Company did not satisfy the requirement of the Collateral Agency Agreement, providing for a certification by the Company on each requisition that Other Project Costs are not reasonably expected to exceed amounts budgeted therefore in the aggregate in the Other Project Costs Budget.

The Company also did not satisfy the requirement the Collateral Agency Agreement, providing for a certification by the Company on each requisition that the Committed Funds are reasonably expected to be sufficient to complete the Project according to the terms of the EPC Contract and the Other Project Costs Budget. The Collateral Agency Agreement provides that, due to the omission in Requisition 38 of the certifications, any subsequent requisition submitted by the Company that omit any required certification shall not be funded by the Trustee and Collateral Agent if the beneficial owners of at least a majority of the aggregate principal amount of the outstanding Series 2013 Bonds direct the Trustee and Collateral Agent not to fund the requisition. After the payment of Requisition 38, the remaining amounts on deposit with the Trustee and Collateral Agent for Project costs are $41,038,647 in the Equity Construction Account of the Company Construction Fund, $0 in the Equity Contingency Account of the Company Construction Fund and $0 in the Indenture Construction Account.

This all matters because if the plant can’t be completed and operated hence the bondholders will have to rely on debt service reserves and the willingness of the foreign owner to provide additional funds for debt service. If the market is concerned it isn’t showing up in prices with bonds trading through the coupon below 5%. One has to ask if that is enough to compensate for the risk.

ATLANTIC CITY BRINKMANSHIP CONTINUES

The mayor of this New Jersey resort city said on Monday that dismal finances would force a three week long shutdown of all nonessential government services starting early next month if the city does not get state aid. Mayor Donald Guardian, a Republican, said the shutdown would start on April 8 and was likely to last until at least May 2, when quarterly tax revenue is set to arrive. Police, fire and sanitation workers would perform their jobs without pay but would be paid when the tax money came in. Mr. Guardian said the city could be in a similar situation in a couple of months, especially if the state withheld aid. The city’s tax base has contracted since four of its 12 casinos closed. State lawmakers are debating a financial takeover plan that Mr. Guardian said goes  too far in wresting control from city officials. The comments reflect the conflict between the City and Governor Christie who in his usual low key way said that he would not sign the legislation if “one word” in it was changed.

MUNIS REMAIN AT THE FOREFRONT ON NEW NUCLEAR DEVELOPMENTS

From 2029 to 2035, three dozen of the nation’s 99 reactors, representing more than a third of the industry’s generating capacity, will face closure as their operating licenses expire. Nuclear energy, which provides 19 percent of the nation’s electricity but has struggled in recent years to compete against subsidized solar and wind power and plants that burn low-priced natural gas. Industry advocates say that by removing sources of clean electricity — a nuclear reaction produces no carbon dioxide or other greenhouse gases — the closings could affect the government’s ability to fulfill its pledge, made at the Paris climate talks last year, to reduce emissions.

The Southern Co. with whom the Municipal Electric Authority of Georgia participates in nuclear generation, announced in January that it would receive up to $40 million from the Department of Energy to develop an advanced reactor that uses molten salt as a coolant instead of water, which all current designs use. The process is being developed by a company called NuScale. It’s design has been under development since 2000. It has lined up a potential first customer, Utah Associated Municipal Power Systems, or UAMPS, which operates in the Intermountain West, and hopes to have 12 of the small reactors operating at a site in Idaho by the mid-2020s. NuScale has been testing its design for 13 years, using a nonnuclear prototype. Later this year, it plans to submit an 11,000-page application to the N.R.C. to have its design certified. The commission then has up to 40 months to review the application.

The certification process, and a later application by UAMPS for a construction and operating license, could be delayed if the N.R.C. asks for more information. But even if all goes smoothly, the plant will produce only about half the electricity of many existing reactors. About 50 of these 12-reactor plants would be needed to replace the generating capacity that could be lost by 2035. Many hope that extending the licenses of existing reactors will forestall at least some closings. Nuclear plants were originally licensed for 40 years, but almost all have sought and received 20-year extensions.

The regulatory commission has begun researching what would be required to extend a plant’s life to 80 years. “We’re asking very basic questions, like how long can a reactor vessel remain acceptable since it’s being bombarded by neutrons,” said a spokesman. “The information we have at this point is that those are issues that are not showstoppers.” So far one operator has announced plans to seek such an extension, for two reactors set to close in the early 2030s, but an application and possible approval are still years away. Duke Energy, owner of the Robinson plant in South Carolina, said it was evaluating whether to pursue an extension.

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

LOWER LAND DEAL DEFAULTS ARE NO SURPRISE

Recently it was observed that land development defaults are slowing. Well to followers of recent data that should not have come as a surprise. For example, the California Association of Realtors (CAR) has released their report on California existing home sales and median prices in January. The statewide median price rose over the year in January by 9.2% to $468,330. The year-to-year price gain was the largest since May 2014 and reflects the shift in sales activity toward higher-priced properties.

Sales of single-family homes increased by 8.8% over the year in January to 383,670 units sold (annualized rate, adjusted for seasonality). This was the highest sales level for a January since 2013. Year-over-year increases were recorded in all three of the state’s major regions: Southern California (6.5%), San Francisco Bay Area (6.8%), and the Central Valley (11.8%). Over the month, sales declined by 5.4%.

Mortgage interest rates edged down in January, with the 30-year, fixed-mortgage interest rate averaging 3.87%, down from 3.96% in December, but up from 3.67% in January 2015. In Los Angeles County unit sales rose by 5.2% over the year in January, while the median price rose by 8.9% to $480,950. In Orange County sales shot up by 15.2% and the median price increased by 4.5% to $704,950. In Riverside County sales of existing homes rose by 7.7% while the median price moved higher by 8.9% to $333,370. In San Bernardino County sales increased by 5.7% in January; the median price jumped by 13.5% to $234,460. San Diego County saw unit sales inch up by 2.9% and the median price increased by 9.2% to $542,150. In Ventura County sales were up by 3.7% over the year while the median price rose by 9.6% to $638,590.

PROPOSED SPECIAL DISTRICT RULES DRAW MARKET IRE

The IRS has proposed regulations requiring that a political subdivision serve a governmental purpose and must be governmentally controlled. They define control to mean ongoing rights or powers to direct significant actions of the entity. Rights or powers to direct the entity’s actions only at a particular point in time are not ongoing and, therefore, do not constitute control. For example, the right to approve an entity’s plan of operation as a condition of the entity’s formation is not an ongoing right. The proposed regulations provide three non-exclusive benchmarks of rights or powers that constitute control: (1) The right or power both to approve and to remove a majority of an entity’s governing body; (2) the right or power to elect a majority of the governing body of the entity in periodic elections of reasonable frequency; or (3) the right or power to approve or direct the significant uses of funds or assets of the entity in advance of that use. Control by a small faction of private individuals, business corporations, trusts, partnerships, or other persons is fundamentally not governmental control.

The proposal generally requires that control be vested in either a general purpose State or local governmental unit or in an electorate established under an applicable State or local law of general application. If, however, a small faction of private persons controls an electorate, that electorate’s control of the entity does not constitute governmental control of the entity. Accordingly, an entity controlled by an electorate would not be seen to be governmentally controlled when the outcome of the exercise of control is determined solely by the votes of an unreasonably small number of private persons.

The proposed regulations rely on certain assumptions. The number of private persons controlling an electorate is always unreasonably small if the combined votes of the three voters with the largest shares of votes in the electorate will determine the outcome of the relevant election, regardless of how the other voters vote. The number of private persons controlling an electorate is never unreasonably small if determining the outcome of the relevant election requires the combined votes of more voters than the 10 voters with the largest shares of votes in the electorate. For example, control can always be vested in any electorate comprised of 20 or more voters that each have the right to cast one vote in the relevant election without giving rise to a private faction. For purposes of applying these measures of concentration in voting power, related parties are treated as a single voter and the votes of the related parties are aggregated.

Well that would certainly seem to drive a stake through the heart of many special district creations. Just look at the formation of special districts like California CFDs, Florida CDDs, and many other assessment driven districts that have issued bonds in the tax exempt market. It is easy to see why the proposed regulations would worry bond counsel, financial advisors, management companies, underwriters and the many other market participants who make a living from these financings. The potentially higher cost of development driven infrastructure could be the margin of difference for many developments.

The Treasury Department and IRS are driven by the potential for excessive private control by individual developers, the excessive issuance of tax exempt bonds, and inappropriate private benefits from this Federal subsidy. The Treasury Department and IRS seek public comment on whether it is necessary or appropriate to permit such districts to be political subdivisions during an initial development period; how such relief might be structured; what specific safeguards might be included in the recommended relief to protect against potential abuse.

AMICUS BRIEFS FILED IN PR SUPREME COURT CASE

Scotiabank de Puerto Rico, the Association of Financial Guaranty Insurers and the U.S. Chamber of Commerce are urging the U.S. Supreme Court in legal briefs to uphold the illegality of the Puerto Rico Debt Enforcement & Recovery Act. , a local statute that allows for the debt restructuring of the island’s public corporations that was found to be unconstitutional at the federal district and appellate levels. The local government contends that because Puerto Rico’s public corporations cannot file under federal bankruptcy law, it can enact its own bankruptcy law to fill in the gap.

Scotiabank, in an amicus brief filed after reaching joining in a restructuring agreement with the Puerto Rico Electric Power Authority (PREPA), says local banks that comprise the fuel-line syndicate, which pays for the utility’s oil, play a vital role in the island’s economy and support initiatives to address its fiscal problems. “But the Recovery Act, moreover, is so unfavorable to creditors—and so much less protective of creditors’ rights than the federal Bankruptcy Code—that it will inevitably affect the financing available to Puerto Rico”. “Although PREPA asserts in its amicus brief that the Recovery Act spurred negotiations on a consensual restructuring, the opposite is true. The Recovery Act reduced PREPA’s incentive to negotiate, and little progress was made before the district court struck down the Act on February 6, 2015. Only after that decision—on June 1, 2015—did PREPA deliver a proposed recovery plan to creditors, as required by its forbearance agreements. And only then could PREPA and its creditors begin to negotiate in earnest on a consensual restructuring,” the bank says.

The Association of Financial Guaranty Insurers (“AFGI”), the national trade association of the leading insurers and reinsurers of municipal bonds and asset-backed securities, says its interest in the outcome of this case extends well beyond the debt issued by Puerto Rico and its public corporations. “The prospect of States or territories enacting their own municipal bankruptcy laws would have grave consequences on the monoline insurance industry, as well as on the municipal bond market as a whole. Upholding the  contractual terms with municipalities could be altered in unpredictable, inconsistent and self-serving ways. This would create a chilling effect on credit markets and increase the cost of financing to municipal borrowers (and, therefore, to taxpayers),” the organization argues.

“This false portrayal of the potential impact of applying existing federal and Commonwealth law to the bond contracts at issue is an attempt to shift focus from the ‘straightforward’ issue of federal preemption here and from the dramatic negative effects that permitting laws like the Recovery Act would have on the nationwide municipal securities market,” the group adds. The U.S. Chamber of Commerce says there can be no bankruptcy uniformity if states and territories could break contracts for the special benefit of distressed municipalities. The result would be a municipal bond market with reduced access to the low-cost capital the investor class has always supplied.

MENENDEZ OFFERS PR RELIEF LEGISLATION

While the legal arguments are made, the legislative process continues to unfold. ‘‘The Puerto Rico Stability Act 5 of 2016’’. to be proposed by Senator Bob Menendez (NJ) provides for the establishment of a fiscal oversight board. Its creation would automatically stay any legal proceedings against the Commonwealth, provide for the Commonwealth to propose a plan of adjustment for its debts, and most importantly establish a first priority ” senior secured statutory lien on Commonwealth revenues in favor of its pension obligations. The Senator summarized the legislation of the floor of the Senate. It comes directly from the current Puerto Rico administrations playbook.

His comments were as follows. “That’s why the first and most important step we must take is to give Puerto Rico the ability to restructure its debts in an orderly fashion.  Our legislation would do just that, providing a fair and reasonable way for Puerto Rico to restructure all of its debts while avoiding a race to the courthouse that would result in years of costly litigation.

“But before Puerto Rico can even access this authority, it needs to affirmatively opt-in and accept the establishment of an independent ‘Fiscal Stability and Reform Board’ and Chief Financial Officer.  This both ensures that any restructuring plan is based on objective and independent analysis of the island’s situation and provides assurances to creditors that future governments will adhere to a prudent long-term fiscal plan, while affirming and respecting Puerto Rico’s sovereignty.

“Once Puerto Rico opts in, it receives an automatic 12-month stay to give government officials the necessary breathing room to organize their finances and develop a sustainable five-year fiscal plan upon which annual budgets and their restructuring proposal will be based.

“Once the Governor submits a restructuring proposal, a judge selected by the First Circuit Court of Appeals would have to confirm it complies with the Fiscal Plan, protects the rights of pensioners, and if feasible, does not unduly impair general obligation bonds.  Our process follows precedent by giving creditors a voice and the ability to object in court, and ultimately gives an independent judge the authority to ensure any plan is fair and reasonable.

“And in order to ensure the long-term fiscal plan is followed not just now, but in the future, our legislation gives the independent Board the power to review annual budgets, future debt issuances, and exercise strong oversight and transparency powers. “If future budgets do not comply with the fiscal plan, the Board has the authority to issue a vote of ‘no confidence’, which will send a strong and unequivocal message to the legislature, capital markets, and Puerto Rican people…”

“The Board will consist of 9 members chosen by the Puerto Rico Governor, Legislature, Supreme Court, and President of the United States.  At least six of the Board members must be full-time residents of Puerto Rico, at least six must have knowledge of Puerto Rico’s history, culture, and socioeconomics, and all members must have financial and management expertise. This proposal wouldn’t cost the U.S. treasury a penny and because it is limited to the territories, wouldn’t have a contagion effect on the broader municipal market.”

“Currently, Puerto Rico’s Medicaid program, rather than being reimbursed for necessary costs, is capped and set to hit a funding ‘cliff’ as soon as mid-2017.  When its Medicaid costs, a burden no state could handle. “There are several policies in Medicare that treat the island differently than the rest of the nation, leaving providers and seniors to face unfair penalties and lower reimbursements.  This bill eliminates many of these discrepancies to more accurately align Medicare policies in Puerto Rico with the rest of the country. “As citizens of the United States, it’s only fair that Puerto Ricans be afforded the same access to care, coverage and health benefits as everyone else.

“Finally, our legislation would incentivize Puerto Rican workers to enter the formal economy and give families the help they need to raise their children by providing parity to the island for the Earned Income Tax Credit and Child Tax Credit.

We think that the reordering of obligations in favor of pensioners would indeed have a contagion impact on the market. The fact that the legislation includes all US territories builds that in. Keep in mind that Senator Menendez’s home state of New Jersey is one of the leading pension underfunding offenders. As for funding and tax credits there has to be some consequence for being a Commonwealth resident and not paying personal income taxes. Years and generations of cultural resistance to the formal economy cannot be overturned simply by enacting this law.

WESTLANDS WATER SACTIONED BY THE SEC

The Securities and Exchange Commission charged California’s largest agricultural water district with misleading investors about its financial condition as it issued a $77 million bond offering.  According to the SEC, Westlands agreed in prior bond offerings to maintain a 1.25 debt service coverage ratio. Westlands learned in 2010 that drought conditions and reduced water supply would prevent the water district from generating enough revenue to maintain a 1.25 ratio. In order to meet the 1.25 ratio without raising rates on water customers, Westlands used extraordinary accounting transactions that reclassified funds from reserve accounts to record additional revenue. Not only did Westlands fail to disclose that wouldn’t have been possible without the extraordinary 2010 accounting transactions, but also omitted separate accounting adjustments made in 2012 that would have negatively affected the ratio had they been done in 2010.

Had the 2010 reclassifications and the effect of the 2012 adjustments been disclosed, Westlands’ coverage ratio for 2010 would have been only 0.11 instead of the 1.25 reported to investors. Westland’s general manager Thomas Birmingham referred to these transactions as “a little Enron accounting” when describing them to the board of directors.   Birmingham and former assistant general manager Louie David Ciapponi improperly certified the accuracy of the bond offering documents.

The SEC’s order finds that Westlands, Birmingham and Ciapponi violated Section 17(a)(2) of the Securities Act of 1933 and must cease and desist from future violations. They neither admitted nor denied the findings. Westlands agreed to pay $125,000 to settle the charges, making it only the second municipal issuer to pay a financial penalty in an SEC enforcement action.  Birmingham and Ciapponi agreed to pay penalties of $50,000 and $20,000 respectively to settle the charges against them. Andrew J. Ceresney, Director of the SEC Enforcement Division said,  “issuers must be truthful with investors and we will seek to deter such misconduct through sanctions, including penalties against municipal issuers in appropriate circumstances.”

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

BUT IT WAS RATED – ANOTHER P3 TOLLROAD CRASHES

Regular readers will remember that we view privately operated toll roads with at best a great deal of skepticism. That position was reinforced with the news last week that the private company that operates part of the Texas toll road with the highest speed limit in the country filed for bankruptcy, fewer than three years after the section of the road it oversees first opened.

The SH 130 Concession Company, a partnership between Spain-based Cintra and San Antonio-based Zachry American infrastructure, opened the 41-mile-long southern portion of the State Highway 130 toll road, from north of Mustang Ridge to Seguin, in October, 2013. The company had signed an unprecedented deal with the state to build and operate its section of the road for 50 years in exchange for a portion of the toll revenue. Lower-than-expected traffic has led to shortfalls in revenue. A year after the road opened, the lack of traffic prompted Moody’s to severely downgrade the company’s debt. Moody’s released a report eight months later warning that the company was dangerously close to defaulting. Now those ratings have been withdrawn.

SH 130, which runs a total of 91 miles from north of Austin to Seguin, was designed as a way to alleviate gridlock on Interstate 35 through the capital city. The southern section is the only part operated by the Concession Company; the rest is run by the state department of transportation. SH 130 Concession Company CEO Alfonso Orol said in a statement that the road will continue to operate while it goes through Chapter 11 bankruptcy proceedings. The company said that, while its current debt payment schedule is “unsustainable,” it hopes to announce a resolution to its financial troubles in the coming months and points to gradual traffic increases as reason for confidence moving forward.

“We believe that this trend will continue and that the road will become an increasingly popular alternative to I-35 and a valuable asset for the Central Texas region in the years to come as connectivity improves and the area’s economy and population continues to grow,” Orol said. When the southern section of SH 130 was first unveiled, then-Gov. Rick Perry hailed the project as a significant achievement for the state, after he had pushed for private toll leases despite skepticism around the Capitol. The Texas Department of Transportation, said that the company’s bankruptcy filing should have no impact on state taxpayers. “No state money was used to build the portion from SH 45SE south to Seguin operated by the SH 130 Concession Company, and the state is not liable for any of its outstanding debt. SH 130 continues to be a viable alternative for drivers who want to bypass Austin and avoid congestion on Interstate 35.”

BUT IT WAS RATED – THE IMPORTANCE OF PROJECT VIABILITY

Recent times have shown yield investors the importance of underlying project viability even in those transactions supported by an implicit or direct guarantee of debt service by an issuing municipality. Recent refusals of communities in Missouri, Illinois and Minnesota have highlighted the issue. Another example is emerging in Florida. In 2010, the City of Port St. Lucie, Florida issued bonds for the benefit of Oregon Health and Science University Vaccine and Gene Therapy Institute Florida Corp., now known as Vaccine and Gene Therapy Institute of Florida Corporation (“VGTI”).

In October, 2015 the City paid the Trustee the amount of VGTI’s loan payment of $1,506,306 which The Trustee applied to the interest payment due on the Bonds on November 1, 2015. As of February 23, 2016, the Debt Service Reserve Requirement of $4,146,212.50 was deficient in the amount of $872,254.58. VGTI made two monthly payments of $218,175 on June 16, 2015 and July 15, 2015 to replenish the Debt Service Reserve Requirement. The City made six additional monthly payments of $218,175 and has committed to make the remaining four monthly payments so that the Debt Service Reserve Requirement will be fully funded by June 15, 2016.

In September 2, 2015 the City requested the appointment of a receiver over the corporate entity VGTI, as well as its real and personal property. Appointment of a receiver would facilitate an investigation of any improper action VGTI may have taken which dissipated the collateral that secures the payment of the Bonds and recovery of any additional revenues to which the Trust Estate may be entitled. While VGTI was generally cooperative in respect to the appointment of a receiver over the property, VGTI aggressively opposed the City’s and the Trustee’s efforts to obtain the appointment of a receiver over VGTI. The Trustee joined with the City in working with VGTI and the State of Florida Department of Economic Opportunity (“DEO”) to draft an agreed upon order for the Court to enter appointing a receiver over the property.

During the course of its remedial efforts, the City obtained from VGTI a draft appraisal of the Bond-financed real property that indicates the project value is less than half of the aggregate principal amount of Bonds outstanding. The Trustee cannot verify the reasonableness of this draft appraisal. The Bond-financed building is a very expensive facility to maintain, even in “cold storage.” The cost to maintain the building by a knowledgeable manager and pay the necessary utilities aggregates approximately $150,000 per month. The payment of these monthly expenses (and other payments made by VGTI) has essentially dissipated the cash balance that VGTI has previously held. The Trustee believes that the City has agreed to pay (within limits) the cost of the receiver and the monthly maintenance costs for the building.

Thus far VGTI and the City have been unwilling to pay the Trustee’s default administration expenses, including the fees and expenses of its counsel. As of January 31, 2016, those counsel fees and expenses aggregated in excess of $350,000. Pursuant to the court’s February 2, 2016 Order, VGTI’s remaining cash of approximately $144,000 was transferred to a default administration account established and maintained by the Trustee. While funds in this account were used to pay the Trustee’s outstanding attorneys’ fees and expenses, the account did not have sufficient funds to reimburse the Trustee for all of its fees and expenses. On January 6, 2016 and February 23, 2016, the Trustee requested indemnification from the City pursuant to the Trust Indenture.

On February 24, 2016, the City contacted the Trustee and stated that it would indemnify the Trustee. Later that same day, the City paid the Trustee $213,549.29 – the amount requested in the Trustee’s February 23, 2016 demand – to reimburse the Trustee for its attorneys’ fees and costs incurred through January 31, 2016. After that payment was received, however, the City’s outside counsel stated that the payment had been initiated “by mistake.” It therefore remains unclear whether the City intends to indemnify the Trustee as required under the Indenture. If the City ultimately refuses to pay those fees and expenses, the Trustee may seek indemnity from the bondholders as is permitted by the Indenture.

VGTI had offered to deed the property to the City in lieu of foreclosure but, the City did not accept. Under the Mortgage, it is the Trustee that holds the mortgage lien. The Trustee did not think it prudent for the Trustee to accept a deed in lieu of foreclosure from VGTI because taking title to the property in the name of the Trustee or a special purpose entity established by the Trustee could adversely affect the exemption from federal income taxation of interest on the Bonds. The Trustee expects to oppose a sale or lease of the building to any entity that is not a governmental body or a 501(c)(3) organization because it believes doing so could adversely affect the exemption from federal income taxation of interest on the Bonds.

Now the bondholders are looking at a situation where they thought that they were  protected to some degree from project economics but in reality were dependant on long-term viability to insure repayment. They are exposed to the declined value of the real estate and a highly uncertain source of funding for the costs of obtaining ultimate recovery of principal.  The continued payment of debt service on the Bonds through the final maturity of May 1, 2042 will then depend upon the City’s willingness to honor its covenant to budget and appropriate and deposit funds into the Debt Service Reserve Fund to cure any deficiency therein.

AND SO WAS THIS

The Rhode Island Economic Development Corporation (RIEDC, now called the Rhode Island Commerce Corporation) issued $75 million in bonds for the 38 Studios project as part of a state government program intended to spur economic development and increase employment opportunities by loaning bond proceeds to private companies. The Securities and Exchange Commission on Monday charged a Rhode Island agency and its bond underwriter with defrauding investors in the bond offering to finance startup video game company 38 Studios.

The RIEDC loaned $50 million in bond proceeds to 38 Studios. The loan and, in turn, bond investors would be repaid from revenues generated by video games that 38 Studios planned to develop. The bond offering document failed to disclose to investors that 38 Studios had conveyed it needed at least $75 million in funding to produce a particular video game. When 38 Studios was later unable to obtain additional financing, the video game didn’t materialize and the company defaulted on the loan. The SEC alleges that the issuer and underwriter knew that 38 Studios needed an additional $25 million to fund the project yet failed to pass that material information along to bond investors, who were denied a complete financial picture.

Investors weren’t informed that the underwriter had a side deal with 38 Studios that enabled the firm to receive nearly double the amount of compensation disclosed in offering documents. This additional compensation, totaling $400,000 and paid from bond proceeds, created a conflict of interest that Wells Fargo should have disclosed to bond investors. Now the State of Rhode Island is on the hook for the debt service on the bonds.

Rep. Karen MacBeth, who chairs the Rhode Island House Oversight Committee, has been arguing for years that tax-payers shouldn’t be the ones paying the $75 million price tag for the failed video game deal. After Monday’s announcement, MacBeth believes there’s even more reason to not pay back the bond. She is planning to introduce legislation that would ban the state from making any further payments to bond holders. MacBeth does not believe withholding funds would hurt the state’s bond rating. “How can we be knocked down in our bond rating with something that’s fraudulent?” MacBeth said.

CHICAGO PUBLIC SCHOOLS ANNOUNCES FURLOUGH PLAN

CPS canceled classes on March 25, Good Friday, as one of three planned furlough days designed to save $30 million. The announcement immediately prompted a renewed strike threat from the teachers union on April 1. The other two furlough days for teachers and school-based workers are set for June 22 and 23, which were to have been professional development days after the end of the regular school year when students would not be in the classroom.

Chicago Teachers Union officials said the furloughs will result in a 1.6 percent salary reduction for its members. “The mayor is already seeking a 7 percent pay cut, and today’s directive adds another reduction in salary and benefits.”  The district’s top labor lawyer said an April 1 walkout would violate state law and promised that CPS would take the issue to court. CPS said “as many as 8,000 staff members” were planning to take Good Friday off, about four times the daily average. CPS said administrative staff will take forced furloughs April 21 and 22, when the district is on spring break.

The district began its fiscal year with a $480 million budget hole that it hoped to cover with help from the state. That assistance has not arrived as the state budget standoff has continued. CPS has managed its cash flow through the year by laying off employees and borrowing.

The furloughs were announced after CPS and the union spent the day negotiating a new contract, and they follow the district’s decision to eliminate its long-standing practice of picking up seven percentage points of a 9 percent salary contribution teachers make toward their pensions. The “pick up” has long been a major issue of contention between CPS and its teachers. The district has said that eliminating the pension pickup for teachers would cut $65 million in spending this year, more than a third of $182 million in planned cuts this budget year. The district has not said when it will stop making the payments, but CTU officials believe the payments could be cut off next month and threatened earlier this week to strike as soon as April 1. That would be well before teachers are allowed to strike under a state-mandated process that is now in its final phase and wouldn’t play out until the end of May.

The union has not officially committed to a strike date. Such an action depends on whether the district follows through on its plans to end the pension pickup. CTU attorney Robert Bloch said that despite the state law, the union can strike under the authority of a 1956 U.S. Supreme Court decision. “The union’s view is that if it’s not striking over the contract, but is instead striking over an unfair labor practice under that Supreme Court decision, it need not fulfill all those statutory requirements for a strike before engaging in an unfair labor practice strike,” Bloch said. “We believe there is a right to engage in a strike without concluding the contractual impasse procedures, because we’re not striking over a contract,” he said.

The district’s top labor attorney, who helped write the state law that strengthened the steps that must be taken before the city’s teachers can strike. The district’s view is that the 1956 Supreme Court case deals with the National Labor Relations Act, which “has absolutely no applicability to the Chicago Public Schools system or to the Illinois Educational Labor Relations Act.” “Strikes are illegal, they’re prohibited except under very specific circumstances,” Franczek said. “The only way you can strike at CPS is if you comply with that (state) statute.” Also at issue is a provision in the union’s contract that states that the pension pickup ends with the contract — which expired June 30. Nonetheless, the union is arguing that the district should continue making the pension contributions throughout negotiations.

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

TREASURY DROPS PENSION BOMB ON BONDHOLDERS …

A draft, obtained by The New York Times, indicates that the Treasury Department is putting forth a plan to address Puerto Rico’s financial crisis which would put pension payments to retirees ahead of payments to bondholders. This would be a huge change for our market. The establishment of such a move which would be highly detrimental to bondholders has long been sought by public employees and their advocates. It would also seem to override prime provisions of the Puerto Rico Constitution which have long been relied upon to offset the irresponsibility of the Puerto Rico political establishment.

“The major problem is, the entire pension system is close to being depleted,” said Antonio Weiss, counselor to Jacob J. Lew, the Treasury secretary. “But 330,000 people depend on it. It’s unfunded, and they have to be protected.” Weiss has previously been the Treasury’s point man for advocating positions negative to bondholders. Shielding retirees from pension cuts, the thinking goes, would not only protect thousands of older residents on the island, but it might also encourage younger retirees to stay there, rather than move to the United States mainland in search of new jobs and incomes.

Out-migration is considered a prime cause of Puerto Rico’s financial decline, because it shrinks the island’s economy, leaving fewer people and fewer dollars to support debt. That out migration has been seen greatly among those population cohorts which are best positioned to support an economy over the long term. These are non-public employees or those (like nurses and doctors and financial professionals) for whom private opportunities on the U.S. mainland will continue to be better than what is available on the island.

But deciding that pensioners’ interests should be put above those of bondholders — if a choice must be made — is not without certain risks. If Puerto Rico can renege on promises to pay debts to investors, while sparing retirees, other municipalities might try to do the same. While it would be “special treatment” for Puerto Rico there huge contagion risk to the entire  municipal market.   Issuers where pensioners have constitutional protection, as is the case in Illinois, would likely cite such a resolution as a way out of their own similar pension funding problems. The Treasury contends that such concerns are unfounded. The framework they are proposing would be designed only for distressed United States territories, like Puerto Rico, and could not be used by states or municipalities on the mainland.

The problem is that once established, it would be hard to limit the precedent set. We disagree with the notion that most institutional investors understand Puerto Rico’s unique situation and the coming debt restructuring will not create widespread credit implications. Moving public pensions to the top of the flow of funds would greatly upset bondholders — especially those who paid close to face value for their bonds years ago, when they were still rated investment grade, and who had expected to hold them to maturity and get all their principal back.

Although the Puerto Rico government has sought to portray the bondholders as deep-pocketed vultures since Puerto Rico’s debt crisis began, many of them are small investors, themselves trying to save for a comfortable retirement. Many are over 65, and they mostly have incomes of less than $100,000 a year. They are not vulture funds. They are regular individuals. This reflects the above average yields and interest that was exempt from federal, state and local taxes, no matter where the buyer lived.

A version of Treasury’s plan was outlined in a draft bill presented to a Senate committee; it has not been voted on. The draft document also is said to call for a five-member “fiscal reform assistance council” appointed by the president to hold the island to meaningful budgeting, disclosure and fiscal reform practices. The board would have the power to make across-the-board budget cuts if necessary.

Currently, Puerto Rico’s laws and Constitution give top priority to general-obligation bonds — the type backed by the government’s “good faith, credit and taxing power.” In general, its bonds can be ranked in a hierarchy of eight levels, with general-obligation bonds at the top. The ranking is described in according to an analysis of the debt by the Center for a New Economy, a nonpartisan research group in San Juan. Public workers’ pensions, the center found, fall on a second hierarchy altogether, which sets priorities for the government’s operational disbursements. Here again, however, payments due on general-obligation bonds come first, followed by payments due on legally binding contracts. Outlays for pensions come third.

The Treasury’s proposed restructuring framework would change that. It would require that the restructuring plan “not unduly impair the claims of any class of pensioners.” General-obligation bondholders, on the other hand, would get such protection only “if feasible,” according to the draft that outlined the plan.

… WHILE PR GOVERNMENT FOLLOWS UP

Puerto Rico will run out of cash to meet the more than $2.5 billion in debt-service payments it owes this summer, beginning with $422 million due May 2 by the cash-strapped GDB. After putting forth earlier this year a voluntary debt-restructuring offer to creditors, the administration is already “working to develop a counterproposal that is responsive to all of the creditor feedback but falls within the parameters of the commonwealth’s ability to pay,” according to a presentation made this week to investors. The exchange offer targets about $49 billion in “tax-supported debt,” including general obligations (GOs), Sales Tax Financing Corp. and various other public entities.

According to the  presentation given Tuesday by Puerto Rico officials during an investor event in Miami, Chapter 9 is now insufficient to tackle its problems. Among the reasons Chapter 9 won’t be enough for Puerto Rico, the officials mentioned it would fail to cover such credits as GOs, Cofina and pension systems. Commonwealth officials believe an effective process to restructure Puerto Rico’s tax-supported debt should be comprehensive enough to cover GOs, Cofina and pensions, while everything is done under one coordinated proceeding. It should provide for bringing holdouts onboard any deal potentially reached with a majority of creditors, while establishing access to interim funding through a process known as “debtor in possession” (DIP) financing, as well as a temporary stay on litigation. A fiscal oversight council — a commonwealth entity authorized and designed by federal statute — should also be established.

PR believes the plan should comprise an out-of-court process, whereby an overseeing federal court would first appoint a mediator in the restructuring talks between Puerto Rico and its creditors, amid a short-term litigation stay and DIP financing to finance government operations. If an acceptable deal is reached by the majority, the court would then make it binding on all creditors. If no accord is struck, an in-court proceeding similar to Chapter 9 would follow, although with the broadest definition of instrumentality and streamlined standards for eligibility.

DETROIT PENSIONS BACK IN THE NEWS

For an example of why settlement of the Puerto Rico situation matters to others, one only has to look at Detroit just two years after its bankruptcy. Mayor Mike Duggan, heading into his 2016-17 budget presentation before the City Council last week, said that he’s concerned about the long-term impact of a $491-million pension shortfall that threatens to balloon payments to the city’s two pension funds in 2024.Duggan said there’s no question that extra tens of millions of dollars a year the city will have to pay to the pension funds could cut into reinvestment efforts aimed at improving critical city services such as public safety and blight removal.

The city is running ahead of budget for the year — with a projected $34- million surplus — that gives the city a cushion. Duggan planned to propose to the council that the city make an additional $10-million pension payment this year in 2016 to begin paying down the extra pension costs, which the city blames on mistaken actuarial assumptions used by consultants in Detroit’s landmark Chapter 9 bankruptcy. Detroit’s population decline is slowing, people are moving back into the city, and property values are rising significantly in a majority of Detroit’s neighborhoods. If that trend continues it will generate enough revenue in property taxes so that the city can pay to upgrade public services and meet its pension obligations.

The bankruptcy was supposed to have settled the city’s shortfalls in paying into the Police and Fire Retirement System and the General Retirement System, but an actuarial consultant for the pension plans now estimates the funds will be $491 million short, leading to higher payments than expected beginning in 2024. The consultant, Gabriel, Roeder, Smith, said bankruptcy consultants used outdated life expectancy tables — estimates on how long retirees will live to collect their pensions — in projecting the city’s total pension obligation.

Duggan said the city plans to manage the problem now with additional payments instead of dealing with a crisis in 2024. Detroit is now looking to hire a consultant to verify the pension plan shortfall and determine the best way to pay for it. The city ultimately may end up making even larger payments to cover the shortfall in 2017 and subsequent years, or continuing payments in years where the city’s long-term budget calls for lowering them.

“We’re just really disappointed  that we came out of bankruptcy having been told — and everybody was told in the grand bargain — the pension shortfall was solved, and now it appears it was not,” Duggan said. The grand bargain was the deal in which the State of Michigan, charitable foundations and the Detroit Institute of Arts pledged the equivalent of $816 million to reduce cuts to city pensioners in exchange for sparing the museum from having to sell art in Detroit’s bankruptcy.

NEW JERSEY WINS PENSION DISPUTE

The U.S. Supreme Court has declined to rule on a major case involving payments to New Jersey’s pension system for public employees. The case – Burgos v. State of New Jersey – concerned Governor Christie’s decision to cut billions of dollars in payments he had once promised for the retirement system. As a part of his plan to address New Jersey’s negative financial outlook, Governor Chris Christie signed legislation that was described as requiring the State to make increased annual payments to shore up the State’s woefully unfunded pension systems. As time went on and the State’s economic recovery lagged national trends, the State finances continued to be strained and its credit continued to be downgraded.  In order to balance the State’s budget in 2014, Christie began to cut those payments despite having signed those laws in his first term that pledged more than $16 billion over seven years for the troubled retirement system.

Public worker unions then sued, arguing that Christie and the state Legislature could not skip the higher payments. The New Jersey Supreme Court disagreed, ruling 5-2 that the seven-year plan was not legally binding. In an order issued Monday, the U.S. Supreme Court declined to review that decision. As is their custom, the justices did not give reasons for declining to hear the case. It is likely that they did not see a federal constitutional issue in the case which required their review. This means that the ruling by the New Jersey Supreme Court stands as the law.

DETROIT SCHOOL FINANCES

Retired bankruptcy judge Steven Rhodes been named by Gov. Rick Snyder as the new transition leader for the district the district as it addresses the debt crisis in Detroit Public Schools. The District will need financial help from state lawmakers to provide the additional cash the district needs to reorganize and pay its debts — a necessity given the district is expected to run out of money this spring.

Snyder has backed legislation that calls on lawmakers to approve an additional $715 million in state funding to pay off the district’s $515-million operating deficit and fund the creation of a new debt-free district to educate Detroit children. But getting legislation through could be a difficult task. Lawmakers in the House and the Senate have introduced two very different packages of bills aimed at trying to fix the district.

Rhodes said his first priority will be to obtain accurate and complete, detailed cash-flow projections of what revenue and expenses will be, what they are projected to be through the end of the year. He said he plans to make that information available to the public. It  is troubling that once again a major municipal issuer is in financial trouble and that the information about its finances is not clear and available for a resolution to be quickly implemented.

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.