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.


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