Monthly Archives: July 2015

Muni Credit News July 30, 2015

Joseph Krist

Municipal Credit Consultant


PREPA disclosed that it is seeking to push debt maturities on its $8.1 billion of bonds back by five years, during which time no principal would be paid and interest would be cut to 1%, unless the authority’s cash position warrants it. Those features contrast the more common approach of simply cutting principal and interest payments. Under PREPA’s plan the debt of the forbearing bondholders and the debt of those non-forbearing bondholders who elected for this plan would be subject to what the Commonwealth is calling a moratorium. Non-forbearing bondholders would also have the right to elect to take immediate payments with haircuts from 30 to 35%.

In PREPA’s plan, insured debt would be excluded from these treatments.

The president of the House of Representatives Jaime Perelló said, “We are going to start a dialogue case by case concerning our (the Commonwealth’s direct) debts to see if we can extend their payment by five years,” the same period found in PREPA’s proposal. PREPA made its proposal to its bondholders on June 25, though it was not made public until after Perelló’s comment.

Perelló is one of five members of Puerto Rico’s government sitting on the Working Group for Economic Recovery for Puerto Rico, which is assigned to come up with proposals for restructuring the commonwealth government’s debt by Sept. 1.

One has to turn on the old way back machine to find an example of the kind of fiscal semantics being attempted by PR officials. The last time that this stunt was attempted was by New York in 1975 when it enacted a ‘debt moratorium’. This was seen for the semantic game it was and fooled no one while NY claimed that it had not actually ‘defaulted’ on the debt, they just postponed repayment.

PREPA is the logical candidate for a restructuring as a revenue backed enterprise with a discrete source of revenues for operations and debt service. There could be many reasons for creditors in this scenario to go along with a restructuring of that kind of enterprise. In the case of tax-backed debt like GO’s, the issue is much more difficult as the creditors will potentially viewed as being in direct competition with the provision of essential services.


The dimensions of the fault line between creditors and the current administration become clearer this week. Centennial Group Latin America, a consulting firm, based in Washington, was hired several months ago by the group of hedge funds and other investment firms to analyze Puerto Rico’s economy and finances. It produced a study for that group, the Ad Hoc Group, which includes Fir Tree Partners, Brigade Capital Management, Monarch Alternative Capital and Davidson Kempner.

The Ad Hoc Group owns about $5.2 billion of debt, mostly general-obligation bonds and other bonds that are guaranteed by the central government. Economists working for that group say that the government could solve its debt crisis largely by improving tax collections and obtaining additional financing over the next two years. The message of sustainability is in real contrast with the recent announcement by Puerto Rico’s governor, Alejandro García Padilla, that the commonwealth’s debt is “unpayable.”

“There may be an issue of liquidity in the short term,” in Puerto Rico, “but the debt itself, in global terms, is sustainable,” according to the hedge funds’ consultants.  They estimate that Puerto Rico would need short-term financing of about $2.5 billion to get through 2016 safely. That would cover current overdue bills to vendors, scheduled payments on existing debt and finance a budget deficit projected to be less than $500 million.

The economists said they were not suggesting that Puerto Rico ought to impose any more tax increases on residents who were already paying the taxes they owe. The report shows the commonwealth collects far less of the taxes due than the 50 states, and that it would not have to increase tax rates at all if it could capture what residents are now supposed to be paying. The advisers also argued that Puerto Rico could improve its finances by privatizing the operation of its public works. The commonwealth had already contracted with a Mexican firm to operate its largest airport, and privatized of its toll highways.

Some of the hedge fund holders also offered earlier this year to loan Puerto Rico about $2 billion, to help get the commonwealth through another year of its perennial budget shortfalls. But the government declined those offers, saying the terms were too onerous. Víctor Suárez, chief of staff to Gov. García Padilla said, “The simple fact remains that extreme austerity placed on Puerto Ricans with less than a comprehensive effort from all stakeholders is not a viable solution for an economy already on its knees.”

On the funding side, a $2.95 billion bond issue through the Puerto Rico Infrastructure Financing Authority (AFI by its Spanish acronym) will not be pursued at this time, as “there is no market for it,” Suárez said Monday. The deal was intended to repay a $2.2 billion loan that the Government Development Bank (GDB) provided to the Highways & Transportation Authority (HTA), after transferring the loan to AFI. Recent hikes to the petroleum-products tax were legislated to serve as repayment source for the transaction and would have also provided cash for HTA operations.

“We are trying to achieve a smaller transaction, with reasonable terms, of some $400 [million] to $500 million,” according to Suarez. Meanwhile, Puerto Rico is seeking to finalize before mid-August a $400 million TRANs deal from three public corporations in a bid to ease the commonwealth’s current cash crunch. The commonwealth faces a $59.7 million payment on Public Finance Corp. bonds on August 1. We have discussed previously that Puerto Rico would be unable to meet with the current government’s liquidity. The government has reiterated that the priority will always be to provide essential services to citizens, such as security, health and education.


Cook County Judge Rita Novak threw out the pension changes adopted earlier this year by the City of Chicago on Friday. Her decision was based on an earlier Illinois Supreme Court ruling that said similar changes to state pension funds violated the state constitution. The decision was not unanticipated.

The overhaul sought to eliminate a $9.4 billion unfunded pension liability by cutting benefits and increasing contributions. Workers, retirees and labor unions sued, saying the constitution prohibits reducing pension benefits. In a statement Friday, Chicago corporation counsel Stephen Patton says the city is disappointed in the decision. He says the city looks forward to having its arguments heard by the Illinois Supreme Court.

Those arguments include the City’s contention that the City’s changes preserved and protected the funds from the depletion of their assets. It further legally binds the city to actuarially based contributions to fully fund the system, and obligates the city on pension annuities, which the city argued prior statutes did not. The judge said that this argument was “wholly inconsistent with constitutional teachings” saying “it disregards the settled distinction between pension benefits, which are constitutionally protected, and funding choices, which are not.”

Another argument was that the new provisions afforded fund members provide consideration for the cuts, a legal theory in contract law that allows for detrimental changes to be made in exchange for some perk if parties agree. The city notes that 28 of 31 impacted unions signed off on the plan. The judge said that the city failed to show it had authority for such an expansive interpretation of a “bargained-for exchange.” She further found that argument fails in ignoring the individual rights of fund members who are not in the unions that were party to the negotiations.


This month an Orange County Grand Jury released a report that helps investors to understand what analysts face in trying to obtain and follow important credit-related data supporting this important class of largely non-rated debt. Much of this debt is held by individuals and their mutual fund proxies. The review covered only community facilities district debt issued within Orange County. Its findings, however have broad implications for the sector statewide.

The Grand Jury found that there is a significant lack of transparency regarding CFDs. Information pertaining to a CFD that is provided to the homeowner often does not include the intended purposes of the special tax. Administrative costs and servicing costs of the bond are often not openly revealed. It has been suggested to the Grand Jury that the only way to get good information is for the homeowner to request detailed accounting records (internal financial statements) of the CFD-T under the Freedom of Information Act. There is a lack of transparency to homeowners relative to how CFD funds are being used.

The Grand Jury discovered that the State does not require a complete accounting of the use of CFDs. The only information required by the State CDIAC is the original amount of bond funding, bond balance, taxes outstanding to be collected, and the end date of the bonds. There does not seem to be appropriate oversight and auditing of CFDs and special tax expenditures within the County of Orange. While the assumption is that the CFD debt would be repaid in a finite period of time, there is a mechanism available to controlling entities to extend debt obligations and thereby extend the CFD special tax in perpetuity.

The Grand Jury recommended that each local agency that established a CFD should create an oversight committee and an audit committee to provide for an independent, transparent view of the manner in which CFD funds are being expended. Audit report information, as delineated in California Government Code, 1982 § 53343.1, should be made available to the CFD taxpayers on a website after each fiscal year for each CFD number.


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It’s time to rest and recharge so we will not be publishing in the first two weeks in August.

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.

Muni Credit News July 23, 2015

Joseph Krist

Municipal Credit Consultant


The Puerto Rico Public Finance Corporation  failed to make a $93.7 million debt-service payment last Wednesday. The corporation’s bonds are backed by a pledge that the Puerto Rican legislature will appropriate the cash needed to pay them down. But lawmakers did not appropriate the funds as promised. “In accordance with the terms of these bonds, the transfer was not made due to the non-appropriation of funds,” said the Government Development Bank. So far Puerto Rico has been making its scheduled payments on its $13 billion of general-obligation bonds. The move follows by only two days a presentation to investors in which the Commonwealth gave no indication of an impending failure to pay.

It is not a surprise that the Commonwealth would make such a move but it does further diminish the Commonwealth’s credibility in terms of the representations it makes and has made to investors over time. The upcoming debt restructuring negotiations will require mutual good faith to succeed but the Commonwealth seems to be willing to diminish that asset rather quickly. We believe that this move will simply strengthen the demands of investors for strong, binding, outside oversight and that those investors already inclined towards litigation will continue to pursue it.

While technically, the failure to transfer the funds was attributed to the failure by the legislature to appropriate the funds, the government admitted this week that regardless of the legislative action needed to enable the allocation, cash flow is not sufficient today to meet the Aug. 1 payment.

July is an important month for the commonwealth, as an estimated $1.92 billion in payments are due, according to data from the GDB and the Financial Times. These include payments of $630 million in general-obligation (GO) debt service; $415 million from the Puerto Rico Electric Power Authority for debt service; $390 million for other GO credits; and $300 million and accrued interest in tax revenue anticipation notes. On July 31, a payment of $92 million for a general fund debt is due.


A letter from Sen. Orrin Hatch of Utah to the U.S. Treasury Secretary included a variety of questions which serve as a good basic primer for individuals interested in the PR debt situation. We offer excerpts from the letter including the questions that the Senator has for the Secretary.

What is the administration’s position on stand-alone proposals to allow Puerto Rico’s government to be treated as a state under chapter 9, including retroactive application to already outstanding indebtedness?

Has the administration given consideration to appointing a special mediator or arbitrator to work with Puerto Rico and its creditors to establish an orderly resolution of a Puerto Rican default?

What is the administration’s position on exempting Puerto Rico from the Jones Act, as recommended in the so-called “Krueger report?”

What is the administration’s position on exempting Puerto Rico from federal minimum wage law, or reducing the level of the federally-imposed minimum wage as President Obama has done in other instances (e.g., delays of scheduled minimum wage increases for American Samoa and for the Northern Mariana Islands), where the President acknowledges that a one-size-fits-all federal minimum wage can be costly to residents in areas where productivity and living costs are well below the national averages?

The government reportedly is “consulting with a group of bankers from Citigroup who advised Detroit on a $1.5 billion debt exchange with certain creditors” and “United States Treasury officials…have been advising the island’s government in recent months amid the worsening fiscal situation.” What advice have Treasury officials been offering to Puerto Rico? Have Treasury officials pledged any federal resources to Puerto Rico in conjunction with the advice, including expediting fund flows from the General Fund of the U.S. Treasury to Puerto Rico?

What actions are officials from Treasury’s recently formed Office of State and Local Finance taking with respect to Puerto Rico’s assertion that its debts are not payable? What “potential federal policy responses” have the Office of State and Local Finance at Treasury developed?

Does the administration intend to appoint an official to manage any federal aid packages to Puerto Rico, as was the case when former administration official Don Graves was appointed to manage aid given to Detroit following its filing for bankruptcy?

Do you, as Chair of the Financial Stability Oversight Council (FSOC), still agree with the assessment in FSOC’s latest annual report that “Despite problems exhibited by Puerto Rico, there has been little spillover thus far to the broader municipal bond market.”? Do you also still agree with the FSOC annual report that notable municipal defaults in recent years, though “severe events,” “appear to be idiosyncratic and not representative of a broader trend in municipal credit?”

Are there any anticipated executive actions under discussion among administration officials with respect to any changes in Treasury rules or regulations that may affect how the federal tax system impacts residents and businesses in Puerto Rico or the flow of transfers from the General Fund of the Treasury to Puerto Rico?

Does the administration intend for its proposed 19 percent minimum tax on foreign income to be applied to Controlled Foreign Corporation (CFC) operating in Puerto Rico in the same way it would apply to CFCs operating elsewhere?

For over four years, pursuant to Treasury Notice 2011-2, a Puerto Rican excise tax has received treatment from the Internal Revenue Service (IRS) as though it was eligible for the Foreign Tax Credit. The Notice stated that the excise tax presents new concerns and that “determination of the creditability of the Excise Tax requires the resolution of a number of legal and factual issues.” Until such a resolution, the IRS has not and is not challenging claims as to the creditability of the excise tax. Furthermore, the Notice states that if the IRS eventually decides that the excise tax is not creditable, such a lack of creditability will only apply on a forward-going basis.

  1. When will Treasury finish its review to determine the creditability of the excise tax?
  2. Are there other examples of Treasury, currently or in the past, allowing a tax to be eligible for Foreign Tax Credit treatment while the tax is under examination?
  3. Has Treasury ever announced that, if a tax was determined to not be eligible for the Foreign Tax credit, such a lack of eligibility would apply on a prospective basis?

Many of these items fit the desires of the current administration in PR. At the same time, regardless of the Administration’s position on any or all of these topics, it is not clear that a political consensus exists in Congress to resolve all of these issues in Puerto Rico’s favor.

In the meantime, the Congressional Joint Committee on Taxation approved an  extenders bill which would extend through the end of 2016 two Puerto Rico-related tax provisions. One provision would temporarily increase the limit on the amount of excise taxes on rum that are distributed to Puerto Rico and the U.S. Virgin Islands. Under the bill, the territories would be able to receive $13.25 rather than $10.50 per proof gallon. The JCT estimated that extending this provision would lead to federal outlays of $336 million over ten years. The other provision would allow a domestic production activities deduction to be applied to activities in Puerto Rico. Under current law, special domestic production activities rules for the commonwealth apply for the first nine years of a taxpayer beginning after Dec. 31, 2005 and before Jan. 1, 2015. Under the bill, the rules would apply for the first eleven years of a taxpayer beginning after Dec. 31, 2005 and before Jan. 1, 2017.


California Gov. Jerry Brown has signed a new law securing revenues for general obligation bonds issued by local governments — a law intended to protect bondholders in a bankruptcy proceeding. The law – SB 222 – is designed to preserve bondholder rights to the tax revenues used to back bonds, which are received by a municipality after it enters bankruptcy proceedings. The bankruptcy code defines statutory liens like those mandated under SB 222 as created by force of law, as opposed to consensual liens that are created by an agreement. “Secured” creditors of a bankrupt municipality are supposed to be first in line to recover their money, but California law was previously silent on whether local GOs were “secured” for that purpose. The new law addresses that ambiguity.

The need for the law would seem to pose somewhat of a dilemma for those who had previously expressed certainty that the statutory lien for voted GO debt had already been established. The attorney who drafted the law said “many have argued that the taxes levied to pay California GO bonds are ‘special revenues’ under the bankruptcy code, but this analysis has never been certain. This is the first time we have been able to say that GO bondholders are secured creditors in a municipal bankruptcy. Being a secured creditor in bankruptcy dramatically decreases the risk of nonpayment. This newfound certainty should permit investors and rating agencies to focus more narrowly on the tax-base as the credit for California GO bonds, and less heavily on issuers’ general funds.”

The new law, which becomes effective on Jan. 1, is very similar to legislation enacted in Rhode Island in 2011 after Central Falls filed for Chapter 9 protection.

Moody’s Investors Service said “Generally speaking, the security for California local government GO bonds is a dedicated, unlimited, voter-approved property tax levy, the proceeds of which cannot be used for any purpose other than the bonds authorized by voters. The California Constitution makes the debt service levy separate from the property tax levied for operating purposes. State statute is nonetheless silent on whether GO investors would be secured in the event of a local government’s bankruptcy filing, and case law on this matter is also very limited. The new law is positive for GO investors because it clearly establishes their secured status.” However, it said it would not likely have a “material effect” on the ratings of California local GOs.

Fitch Ratings took a different view saying “revenues supported by a statutory lien are not free from the automatic stay of a municipality’s general revenues once bankruptcy proceedings begin.  Rather, the statutory lien prevents the municipality in a bankruptcy from generally diverting the revenues subject to the statutory lien. The statutory lien does not prevent use of the revenues in the bankruptcy process as long as adequate protection for recovery is offered to bondholders benefiting from the statutory lien. These protections will not guarantee full or timely repayment, only potentially higher recovery.”


Rhode Island’s capital city is considering a law to prohibit smoking throughout the downtown, a ban that an advocacy group says is the most wide-reaching one it’s seen. The ban would improve the quality of life for residents and visitors, according to proponents, but some business owners are concerned it could actually drive away customers. The state was one of the early issuers of tobacco securitization debt.

The proposed law would cover non-enclosed sidewalks and other pedestrian areas, including alleys, that are accessible to the public anywhere in downtown Providence. Smoking would only be allowed in private residences and vehicles. Smokers who break the law could be fined up to $250. The city banned smoking indoors in businesses including bars and restaurants in 2005. The Providence smoking ban would cover more area and prohibit smoking in all of downtown, an area that is defined by the city as about one square mile. Public hearings could begin in September.

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.

Muni Credit News July 16, 2015

Joseph Krist

Municipal Credit Consultant


Puerto Rico Gov. Alejandro García Padilla signed legislation allowing the government to suspend general obligation bond set-asides early in the fiscal year and requiring the government to address deficits as they develop. A 1976 law required the government to set aside a proportionate amount of upcoming interest and principal coming due. The bill signed Friday overturns this law. The bill also will allow the government to borrow about $400 million from three commonwealth-run insurance funds. The State Insurance Fund, the Administration for Compensating for Automobile Accidents, and the Insurance Fund for Temporary Non-occupational Incapacity will lend the money.

Most of Puerto Rico’s revenues come in late in the fiscal year, which has required the government to issue short-term debt at the start of the fiscal year and pay it off near the end of the year.

The legislation would seem to conflict with the Puerto Rico Constitution. Article VI, section 8 of the Puerto Rico constitution reads, “In case the available revenues including surplus for any fiscal year are insufficient to meet the appropriations made for that year, interest on the public debt and amortization thereof shall first be paid, and other disbursements shall thereafter be made in accordance with the order of priorities established by law.” The Governor’s office however took the stance that “the suspension of these deposits does not imply a breach with the bondholders on the date of payment,”.

Puerto Rico House of Representatives Treasury and Budget Committee Chairman Rafael Hernández Montañez contends that the government will only stop the set-asides if it cannot borrow the $1.2 billion in intra-year funding or the Puerto Rico Infrastructure and Finance Authority cannot sell a $2.9 billion gas-tax supported bond which seems to be the current case.

The new law also requires the government use its normal reserves and set up a separate budget reserve at the GDB. In this way the amount in reserve can be more easily monitored. The law requires that if the reserve is drawn on, steps be taken to replenish it.

The Commonwealth followed up the legislative action with an investor meeting at the beginning of this week. It was, in many ways, the opening act in a long but predictable play. As is often the case, the presentation was obvious and unfulfilling in that it really was just a presentation of known facts rather than a framework for action. In many ways it continues a tradition of uninformative presentations which have become an unfortunate hallmark of the Commonwealth’s management of its credit relations. Nevertheless, it did serve to reiterate some things which have been clear for some time.

On the positive side, the Commonwealth denies that it is looking for direct Federal monetary aid. That would at least show a degree of realism about the appetite in Washington for direct fiscal aid. It wasn’t available for Detroit so there is no reason to suspect that it would be there for Puerto Rico. The need to get its own fiscal house in order as well as the need for some level of investor-accepted oversight was acknowledged. In addition, it was clear that the need for structural economic reform in the form of a more productive and legitimate economic structure was emphasized.

On the negative side, it appears that the Commonwealth is looking for debt relief over an extended period – at this point some 8 years. In addition, it is obvious that the Commonwealth ties serious reforms of the government employment and compensation structure to a haircut for creditors. While it seemed to acknowledge the contradiction between not meeting its constitutional and contractual commitments and market access, the Commonwealth gave no indication that it had managed to reconcile these opposing interests.

On the subject of restructuring, the Commonwealth tried to emphasize the voluntary nature of restructuring but also reiterated support for H.R. 870 authorizing Puerto Rico municipalities to declare bankruptcy under Chapter 9. Sens. Chuck Schumer, D-N.Y., and Richard Blumenthal, D-Conn. introduced companion legislation to H.R. 870 as we go to press. The emphasis on partnership, transparency, and all of the other current terms of art as well as references to Greece were not reassuring. The Commonwealth did all it could to encourage a quick resolution (obviously) and positioned itself to blame creditors if a protracted negotiation impeded economic recovery.

The reliance on economic recovery as a source of resources for repayment of debt going forward is no surprise. At the same time, the Kruger Report does lay out how many competitive forces work against Puerto Rico. The emphasis on lower wage costs to attract business could be argued to be a race to the bottom as many lower wage base competitors exist in the Caribbean. Some are better located relative to end markets. And left unsaid in any of the discussions are potential long-term competition from Cuba – effectively an 800 pound gorilla in the room.

We see restructuring and relief as the answers for the Commonwealth rather than reliance on stronger revenues. That implies a protracted negotiation over the terms of debt relief and we believe that there are sufficient differences between the needs of the different creditor groups to indicate a longer rather than shorter process. We also believe that the current stance of the Commonwealth may drive some creditors to legally test the constitutional and contractual supports for the various types of Commonwealth debt. We believe that those tests will occur in or out of bankruptcy.

PREPA, which is already underway with its restructuring, has been trying to achieve it for a year now. As for PRASA, the Commonwealth expressed belief that a rate increase would allow its current debt structure to be supported. That may not be realistic in terms of historic resistance to increases and the drought conditions which are impacting current usage. For 160,000 residents and businesses on the island, currently water is turned off for 48 hours and then back on for 24 hours, sending people into a frenzy of water collection. Another 185,000 are going without water in 24-hour cycles, and 10,000 are on a 12-hour rationing plan. 340,000 households and businesses — about 28 percent of the island’s total — in 13 municipalities are at times going without water.


The Pew Charitable Trusts have released their latest view of the nation’s pension crisis. According to Pew, the nation’s state-run retirement systems had a $968 billion shortfall in 2013 between pension benefits that governments have promised to their workers and the funding available to meet those obligations—a $54 billion increase from the previous year. In 2013, state pension contributions totaled $74 billion—$18 billion short of what was needed to meet the ARC—with only 24 states setting aside at least 95 percent of the ARC they determined for themselves. Illinois continues to have the lowest funding ratio followed by Kentucky and Connecticut at under 50%. Other laggards below 60% include Alaska, Rhode Island, Louisiana, Mississippi, and New Hampshire. New Jersey, a well known pension defunder has seen its funding ratio drop from 68% to 63% in the last two 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.

Muni Credit News July 9, 2015

Joseph Krist

Municipal Credit Consultant


The most recent analysis of a scaled-back, Republican-authored public employee pension reform bill reduces the projected long-term savings from $18.3 billion back to $11.1 billion. None of those savings would show up for state government or Pennsylvania’s school districts in the 2015-16 fiscal year. The analysis done for the Public Employee Retirement Commission said the adjustment rests on House actions to delete a provision to try to unwind 2001 retirement benefit increases.

That clause – sure to invite a court challenge from public sector employee unions – was the biggest single cost-saver in the original bill. It would have required current employees to pay more to keep the higher benefits granted in 2001. New Gov. Tom Wolf opposes increased payroll deductions for existing employees. The remaining reforms include the shift of most future state employees and school teachers into a something more like the 401(k)-style plans now prevalent in the private sector.

In 2001, Pennsylvania’s lawmakers granted pension benefit increases to themselves, plus all public school employees and state workers. They then delayed payments on the resulting higher cost structure in order to avoid tax increases and keep funding available for other state needs. Since then, taxpayer-funded “employer contributions” have grown from under $1 billion in 2010 to more than $4 billion in the fiscal year 2015, and are projected to reach $5.9 billion by fiscal 2016-17.

If  not for the 2001 revisions, the current requirement would about 40 percent of what it is today – or less than $2 billion. The Legislature believes reform requires converting the state’s two major pension plans – at least for future employees – to a 401(k)-style. The Governor, with the support of public sector unions, contends that reforms approved in 2010 for workers hired after that date are working as intended and that funding is the issue. The Governor supports the issuance of $3 billion in bonds secured by increased profits from an enhanced state liquor store system.

The legislature wants employees to contribute 6 percent of their salary for retirement, half in the defined contribution plan matched by 2.59 percent of pay for teachers and 4 percent for state employees. The other three percent of salary would go into a cash balance plan with no additional employer contribution, earning interest tied to yields on 30-year U.S. Treasury bonds, capped at 4 percent. Retirement system gains in excess of that guarantee would be retained by the funds, and go toward paying off their liabilities, a provision union leaders have derided as “inter-generational theft” as new hires see investments on their contributions used to pick up the tab for the changes in 2001.

About 20 percent of the state’s current workforce, mostly law enforcement staff like state troopers and corrections officers, would remain in the current defined-benefit plan, under the House amendment.

The debate is over whether the proposed changes are enough. According to an analysis by the Pew Charitable Trusts’, the biggest discrepancies come for those who work to full retirement, or 35 years, in the public sector. Under the defined contribution plan set out in Senate Bill 1, Pew says a 35-year state worker qualifying for the maximum annuity at age 62 would see their pension drop from 67.6 percent of salary now, to 39.5 percent (assuming annual investment returns of 7.5 percent.)

Assume an average annual return on those 401-(k) investments to 5 percent, and the prospective new worker’s pension would be just 28.6 percent of final salary – an income cut of 58 percent from someone hired today. If the system provides retiree health care benefits, as the State Employees Retirement System does now, proponents argue that the new system – because of an enhanced ability to take funds with them if workers switched jobs – would actually outperform the current defined benefit system for people who leave the public sector before retirement for other careers.

The Pennsylvania State Education Association notes that their members don’t get free health care in retirement, and none of the state or school retirees get an inflation adjustment on their pensions. The PSEA worries that by definition, workers’ benefits will be less certain in the proposed plan because of the built-in risk of depending on future investment returns, as opposed to the current defined benefit plan.

Coloring the debate is the perception that the proposed bill doesn’t appear to generate a lot of savings. For example, the defined contribution portion of SB 1 only generates, according to the PERC report, a long-term savings of about $6.6 billion between both systems. The current PSERS bill through 2035, when pension costs are finally expected to crest, is $109.7 billion. Under the new bill, the cost is pegged at $105.2 billion, or a cut of little more than 4 percent. That is because the biggest savings source –  the piece that tells current workers to pay a higher contribution for the benefit they won in 2001 no longer exists.


Puerto Rico filed a supplement to its May 7 quarterly report that updates the financial state of the commonwealth to reflect recent developments. It states, “if no significant measures are implemented to increase the government’s cash flow, absent new financing from GDB or third parties, during the first quarter of fiscal year 2016 the government may not be able to continue funding all governmental programs and services while continuing to meet all of its debt service obligations in a timely manner.”

The Government Development Bank (GDB) states that the most recent projections point to a fiscal year 2015 budget deficit of $705 million to $740 million, after previously estimating to close this fiscal year with a deficit amounting to about $191 million. That figure does not include nearly $291 million in pending tax refunds. It is also not a figure based on GAAP.

For fiscal 2016, “the Commonwealth faces set aside payments to the Redemption Fund for the Commonwealth’s general obligation bonds of approximately $276 million during the first three months of the fiscal year (approximately of $92 million per month), $93.7 million in appropriations which are due on July 15, 2015 to the Puerto Rico Public Finance Corporation for the payment of debt service, and $300 million in TRANs issued by the GDB plus accrued interest that mature on July 10, 2015, (which the Commonwealth expects to offset during July 2015 with a new $300 million TRANs to be issued by GDB).”

To finance cash needs, the government will delay the payment of income tax refunds by the Treasury and issue about $400 million in TRANs to certain public corporations. GDB President Melba Acosta said that the government was moving forward with various efforts aimed at securing the remaining $800 million needed to operate the government during the beginning of the fiscal year, including a potential deal with private banks that amounts to $400 million.

Legislation also allows the Treasury Secretary to “suspend, totally or partially,” monthly deposits made to cover principal and interest payments on GO debt if it fails to either secure $1.2 billion in TRANs or at least $2 billion in a bond deal backed by the latest petroleum-products tax increase. The supplement also showed a liquidity position at the Treasury Department, with a book overdraft on its cash balance expected to exceed the $271 million figure at the end of May.

Meanwhile PREPA avoided a payment default on July 1 by borrowing from its bond insurers and drawing down its reserves. It’s day of reckoning is now postponed until December.

Supporters of bankruptcy for the Commonwealth may have gotten a boost from a U.S. appeals court affirmation of a lower court decision to strike down Puerto Rican legislation aimed at granting local municipalities the right to enter bankruptcy, but said excluding the U.S. territory’s public entities from federal bankruptcy law was unconstitutional. In the decision, the Court seems to support the idea by saying that “besides being irrational and arbitrary, the exclusion of Puerto Rico’s power to authorize its municipalities to request federal bankruptcy relief should be re-examined in light of more recent rational-basis review case law,”.

Thus the 75-page ruling ostensibly vindicates the suing bondholders’ position, while also making a case that Puerto Rico should be given access to Chapter 9 of the U.S. bankruptcy code, which deals with municipal bankruptcies. Bondholders have consistently opposed this view. The detailed ruling, citing much legislative history, appears to strengthen the case for Congress to act on a bill, currently before a House committee, that seeks to change Chapter 9 to allow Puerto Rico to file for bankruptcy.


Under a settlement announced by Gov. Terry McAuliffe  the Commonwealth of Virginia  will recover $46 million already paid to US 460 Mobility Partners and avoid paying $103 million in additional claims submitted by the developer for the U.S. 460 project. The road  was a four-lane, 75-mph toll expressway between Suffolk and Petersburg which never was able to receive U.S. Army Corps of Engineers approval to destroy wetlands in its planned route. A total of $260 million had been spent the before the project had the permit from the Corps in hand. The project did result in a new state law new law which creates a committee that will include General Assembly representation to ensure that proposed deals under the Public-Private Transportation Act serve the public interest; require the mitigation of potential risks such as federal permitting; and force the secretary of transportation to attest in writing that a project delivers what was promised before a final agreement is signed.

In prior discussions, we had pointed out that the Corps often becomes an effective vehicle for environmental opposition to road development  involving wetlands. It was a surprise that investors did not apparently give this risk the weight it deserved when the bonds initially came to market. While the investors will ultimately recover their principal through a state financed redemption, the intervening threat to principal value and opportunity cost of investing in the project should give pause to those evaluating future projects.


Reports out of the State of Washington show an estimated $250 million in marijuana sales in the past year , generating $62 million in marijuana excise taxes. The state’s original forecast was $36 million. When state and local sales and other taxes are included, the tax take for the state and local governments tops $70 million. One year after legalization, the state has about 160 shops open, sales top $1.4 million per day.

This month, two new laws take effect, one to regulate and tax medical marijuana, and one to cut Washington’s three-level excise tax on pot to a single, 37-percent tax. In Washington, marijuana is taxed at 25 percent each time it moves from the growers to the processors to the retailers. That’s been especially tough on retailers, who must pay federal income tax on the marijuana tax they turn over to the state. The new tax rate should help. The law makes clear that the 37 percent tax is the responsibility of the customer — not the retailer. That means stores won’t have to claim that money as income on their federal filings.

The numbers reflect that few growers were harvesting by the time the first stores opened, with the average price of a gram of legal marijuana rising to nearly $30 last summer — about three times the cost in medical marijuana shops. But prices have been dropping with larger harvests and Washington has harvested 13.5 tons of marijuana flower intended to be sold as bud, but stores have only sold about 10 tons. Some of the excess can be turned into marijuana extracts, such as oil, but the harvest has helped drive down the prices to an average of about $11.50 per gram.

The Washington Liquor Control Board is soon to be renamed the Liquor and Cannabis Board. It regulates the business  by adopting background checks and financial investigations of pot-license applicants, and capping the total amount of production to try to keep it in line with in-state demand. The state required strict packaging and labeling requirements to keep children from buying and products that appeal to them.

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.

Muni Credit News July 2, 2015

Joseph Krist

Municipal Credit Consultant


Puerto Rico Gov. Alejandro García Padilla has announced a working group to achieve a negotiated moratorium with bondholders. He issued an executive order creating the Work Group for the Economic Recovery of Puerto Rico. The group will be led by La Fortaleza Chief of Staff Víctor Suárez; Government Development Bank (GDB) President Melba Acosta; Justice Secretary César Miranda; and the presidents of the Senate and House, Eduardo Bhatia and Jaime Perelló. According to the Governor, “the goal will be to reach a negotiated moratorium with bondholders to postpone debt payments for a number of years so that this money is invested here in Puerto Rico.”

The group will have until Aug. 30 to develop a plan aimed at boosting economic and fiscal reforms so it can be considered and approved in the legislative session that begins in mid-August. According to the Governor, “It is the first time that this kind of comprehensive analysis of the fiscal situation over 10 years, considering the entire government and not only the general fund. This type of analysis has never been done.” That analysis is contained in a study by former officials at the International Monetary Fund and the World Bank which he commissioned. Concluding that the debt load is unsustainable, the “Krueger Report,” as it is known, suggests a bond exchange, with the new bonds carrying “a longer/lower debt service profile,”.

For bondholders, many of the findings reflect long term concerns. As the governor said the report “reveals outdated accounting methods, public corporations without revenue sources, lack of fiscal controls, unreliable statistics and other factors that conspire against the goodwill of many public servants, and which produced the situation we face.” He admitted what many have known – the economy does not generate enough revenue to repay the undertaken obligations.”

Whether his administration is completely willing to deal with al of Puerto Rico’s realities is yet to be seen. For example, his comment that “I will not consider, for example, education as an expense, rather as an investment, nor will I promote lowering the minimum wage for workers, among others. Furthermore, I will defend jobs as the main objective in this process.” He contended that “All the measures we took in the past two years demonstrate our willingness to pay, and had we not taken them, we would not be in a position today to ask for a restructuring. We have done everything in our power but, as the report shows, the next step must be to get more-favorable terms for the payment of our debt”.

The governor described a plan that would establish the parameters for a five-year fiscal adjustment plan, propose further spending cuts, including cuts in some services (“this way we can insist in avoiding tax increases”) and increase revenue based on an operational restructuring of Treasury. He also proposed to promote partnerships with the private sector for the provision of certain services currently provided by the public sector.

That is an idea that has been promoted by many outside observers who have watched agencies like PREPA and PRASA operate inefficiently and uneconomically for many years. As for federal help he asked for changes to Chapter 9 and Medicare. Puerto Rico, like the states, does not have the option of bankruptcy under the federal bankruptcy statutes. A default on its debts will create a state of legal and financial limbo that will take years to undo. It has wide implications for every market participant. Much of Puerto Rico’s debt is widely held by individual investors on the United States mainland, in mutual funds or other investment accounts, and they may not be aware of the extent of that exposure. The monoline insurers have a significant multi-billion dollar exposure to the island’s debt.

The response from Washington was along partisan lines. “Bondholders purchased Puerto Rican bonds at a time when Chapter 9 was not an option,” said Representative Bob Goodlatte, the Virginia Republican who is the full Judiciary Committee chairman. “Proposals to retroactively impact investors’ rights should be reviewed with care and caution.” Democrats said it appeared that Puerto Rico had been denied access to bankruptcy inadvertently, when the most recent amendments to the code were drafted. If Puerto Rico was excluded on purpose, they said, the reason was not clear. The White House press secretary Josh Earnest said on Monday “Detroit did not receive anything you could say was like a federal bailout. “It did receive significant advice. And that did have a measurable impact on their ability to turn their problems around.”

A broad restructuring by Puerto Rico would be unprecedented by a state or near-state equivalent.  It comes on the heels of municipal bankruptcies in Detroit and  Stockton, CA.  It further undermines the assumption that state governments in the United States would always pay back their debt. The governor’s comments were ominous. He said creditors must now “share the sacrifices” that he has imposed on the island’s residents. “If they don’t come to the table, it will be bad for them. They will be shooting themselves in the foot.”

The restructuring process is arguably already underway. Puerto Rico officials and creditors of the island’s electric power authority were said to be close to a deal that would avoid a default on a $416 million payment due on July 1. The government essentially needs to set aside some $93 million each month to pay its general obligation bonds —its constitution requires such bonds to be paid before any other expense. No American state has restructured its general obligation debt in living memory.

The government’s Public Finance Corporation, which has issued bonds to finance budget deficits in the past, owes $94 million on July 15. The Government Development Bank — the commonwealth’s fiscal agent — must repay $140 million of bond principal by Aug. 1. The proposed debt restructuring marks a major departure for Gov. García Padilla, (Popular Democrat) who was elected in 2012. His party favors maintaining the island’s legal status as a commonwealth. Only a few months ago, his administration was considering borrowing as much as an additional $2.9 billion, which would be paid for by a fuel tax.

But the actions to be proposed reflect the results of a study by former officials at the International Monetary Fund and the World Bank which he commissioned. Concluding that the debt load is unsustainable, the “Krueger Report,” as it is known, suggests a bond exchange, with the new bonds carrying “a longer/lower debt service profile”. In June, Puerto Rico hired Steven W. Rhodes, the retired federal judge who oversaw Detroit’s bankruptcy case, as an adviser.  Mr. Rhodes said in a recent interview, “They need Chapter 9 for the whole commonwealth.” The government is also being advised by  Citigroup who advised Detroit on a $1.5 billion debt exchange with certain creditors.

The Commonwealth has been pushing for a federal bill that would allow the island’s public corporations, like its electrical power authority and water agency, to declare bankruptcy. Of Puerto Rico’s $72 billion in bonds, some $25 billion were issued by the public corporations. Some say Congress needs to go further and permit Puerto Rico’s central government to file for bankruptcy.

Hedge funds holding billions of dollars of the island’s bonds at steep discounts are frustrated that the government has not seemed willing to reach a deal to borrow more money from them. In a letter last week, a group of investment firms, including Centerbridge Partners and Monarch Alternative Capital, wrote “we want to be a part of the solution to the commonwealth’s fiscal challenges,” but the Commonwealth has decided that the hedge funds’ debt proposal was too onerous.

A review of the Krueger Report provides a summary of what is so maddening about how P.R. got to this point. The issues of lack of economic development, poor fiscal practices, overstaffing, and inefficiencies are all issues which the investment community has repeatedly brought to the Commonwealth’s attention. They are issues which the investment community has repeatedly cited the necessity of dealing with while the Commonwealth has consistently failed to follow through with concrete actions. There has been no political will exhibited by governments of both major parties. Instead there has been consistent delay and lack of response, albeit a trend facilitated by large investors and financial intermediaries.

For long time analysts of Puerto Rico’s credit, the report merely serves as confirmation. That is not to say that it is not of value. Like many of these sort of reports, it is an important part of any like process in that it provides an objective reference point and initial framework for resolution. The somewhat stark nature of the presentation and its willingness to frame the island’s problems simply and directly create a good starting point for reform.


The Illinois House last week defeated Chicago Mayor Rahm Emanuel’s plan to delay a massive Chicago Public Schools(CPS) pension payment due at months’ end, a result of years of deeply rooted partisan mistrust surfacing in a new era of divided state government. The legislation which would have delayed the CPS pension payment due at the end of the month until Aug. 10. That is when general state aid payments are to be made to school districts — provided a state budget agreement is reached.

The House vote was 53-46. 71 were needed for passage. Democrats have 71 members in the House, but only 37 voted for the measure. The remaining 16 votes in favor of the bill came from among the 47 Republicans. Members who voted against the bill or did not take part in the vote, included five from Chicago. One problem was a lack of detail on how the pension payment eventually would be paid. Many members fearing being targeted in the 2016 election for supporting a bill that could lead to a property tax increase. A series of internal reports indicated that even if CPS emptied its checking account and used all of its cash set aside for other debts, it still would not be able to make the pension payment, cover payroll and pay other bills.

The action comes as the Chicago Board of Education is expected to authorize two borrowing packages totaling more than $1.1 billion to fund district operations through the year. Those loans would be paid off with future property tax collections. Additional property taxes are expected to start flowing to CPS on July 6 and total $816 million by Aug. 10, but that money along with revenue from the state and other sources still would not cover the bills, according to documents that have been presented in recent weeks to union officials and state legislators. Those documents show a negative cash balance of $102 million on Aug. 10.

Legislative leaders promised another vote. In a surprising announcement, House Speaker Michael Madigan said Tuesday afternoon a Chicago schools pension delay bill was moot, since “reliable sources” told him a bill due Tuesday would be paid in full by day’s end. “I’ve been advised by reliable sources they have cash on hand and they’ll be in the position to make the payment before the end of the business day today. The full payment,” Madigan said. When pressed on who told him, Madigan said: “It wasn’t Rahm.”

The consequences to the Chicago Public Schools and its students were far from clear Tuesday. Mayor Emanuel at an news conference earlier in the day refused to say where CPS would get the money or what cuts would take place in classrooms to make the payment.

The Chicago schools pension issue is but one more part of the ongoing partisan battle between the Governor and the House Speaker . Democrats under House Speaker Michael Madigan blamed the Governor for failing to provide enough Republican votes to secure passage. In response, the Governor accused the Speaker of double-dealing, contending that Madigan failed to deliver votes because the speaker was not part of the original negotiations.

The vote also reflects dissatisfaction between Chicago-based legislators and the Mayor over his recent school closings and other efforts to strengthen the finances of the CPS. Some have contended Emanuel was disproportionately targeting the African- American community by closing dozens of schools affecting black children.

A failure to act on pensions could negatively impact ongoing talks on a new contract for teachers further pressuring the CPS finances. The Board’s debt ratings have already been under pressure, especially at Moody’s (Ba3) vs. A- at S&P. The split has already complicated valuations. In its most recent financing, the Board chose not to come with a Moody’s rating. Moody’s has been criticized for having an overly negative view of many Chicagoland credits.

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.