Muni Credit News April 7, 2016

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.

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