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 As the governor said the report “reveals outdated accounting methods, public corporations without revenue sources, lack of fiscal controls, unreliable statistics and other factors that conspire against the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.

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