Muni Credit News July 20, 2017

PUERTO RICO – GDB

The first legal challenge to the proposed restructuring plan for the Government Development Bank (GDB) debt using an agreement with creditors under Title VI of Promesa that was approved by the island’s financial control board last week. The lawsuit—which names the GDB, the Puerto Rico Fiscal Agency & Financial Advisory Authority (FAFAA) and the Municipal Revenue Collection Center (CRIM y its Spanish acronym) as defendants—contends the bank’s restructuring support agreement (RSA) violates the Puerto Rico Oversight, Management & Economic Stability Act (Promesa) and is unconstitutional.

The remedies sought by the city—the first to challenge the GDB’s restructuring deal—include a court order declaring Caguas’ rights as debtor may not be the object of a “qualifying modification” under Title VI of the federal law. The city claims in its suit that “to benefit a select group of creditors of the GDB, at the expense of the Municipality, its constituents and other creditors, the GDB and FAFAA are pursuing an unlawful arrangement, purportedly under the color of law, compelling the Municipality to not only receive the funds it holds at the GDB at a discount, but despite such loss, requiring that the Municipality continue repaying its municipal loans owing to the GDB in full (other than with respect to undisbursed loan proceeds), and in some cases, perplexingly also requiring the Municipality to make loan repayments it has already made under such loans, as if they had not been previously made.”

Caguas had approximately $230.3 million in debt, of which $81.1 million is owed to the GDB. Under the GDB’s advice, Caguas says it incurred in debt using its primary revenue sources for repayment. These include property, sales, operating and gross income taxes.

PUERTO RICO – PREPA

Creditors of the Puerto Rico Electric Power Authority (PREPA) are seeking to lift the Promesa law’s stay and appoint an independent receiver for the utility to oversee certain operations of the public corporation and which could result in increased rates. The motion, which has more than 1,000 pages, was filed Tuesday by National Public Finance Guarantee Corp., the Ad Hoc Group of PREPA Bondholders, Assured Guaranty Corp. and Syncora Guarantee Inc. They seek to enforce their rights after the island’s financial oversight board rejected PREPA’s deal to restructure its roughly $9 billion debt.

The motion comes a day after National and Assured amended a complaint they filed in June, in a separate process in U.S. district court against the fiscal board. the insurers modified their complaint to instead have the court declare that the RSA was a “preexisting voluntary agreement” as defined by Promesa—and thus had to be certified—and that the board’s failure to approve the RSA was unlawful under the federal law.

PUERTO RICO – RETIREMENT SYSTEM

Federal Bankruptcy Judge Laura Taylor Swain approved an agreement struck between the Puerto Rico government and a group of bondholders of the island’s Employees Retirement System (ERS). In the stipulation agreed to, she also scheduled a hearing for Oct. 31, during which the court expects to address a key dispute between the commonwealth and ERS bondholders over rights and remedies related to bonds secured by the government’s employer contributions to the retirement system.

According to the deal, the commonwealth will set aside more than $90 million through the next three months and a half, as well as pay roughly $14 million monthly in interest payments due through October—including a missed payment on July 1. These actions stay the ERS bondholder group’s petition for immediate relief and “adequate protection” as part of the ERS’s bankruptcy case under Title III of the federal Promesa law. By July 21, moreover, the government will commence an adversary action to have the court decide over the “validity, priority, extent and enforceability” of the liens and security interests asserted by the ERS bondholders, as well as the commonwealth’s rights over employer contributions received by ERS in May.

The stipulation calls for payment of some $14 million in interest due July 1 and missed by the ERS, after commencement of its Title III bankruptcy case. The ERS will also pay subsequent monthly interest payments until Oct. 1, or about $42 million in total. These payments will be covered by funds set aside by the commonwealth since January, pursuant to a previous stipulation struck between ERS and its creditors early this year. The commonwealth will set aside $18.5 million in a segregated account on July 31, Aug. 31, Sept. 31, Oct. 31 and two days after Judge Swain’s approval of the stipulation, or July 19, in addition to any money related to employer contributions made by the commonwealth to the ERS in late May.

During the Oct. 31 hearing, Judge Swain will address each side’s final arguments on these issues.

HEALTHCARE BACK FROM THE BRINK … FOR NOW

That sound you hear is a big sigh of relief over this week’s action or lack thereof on the plan to repeal and replace the ACA. There is no doubt that the short term result is positive for both state credits and healthcare credits. But the uncertainty resulting from the President’s reaction that he will “let Obamacare die” will hang over these sectors nonetheless.

First of all, does “let Obamacare die” mean withdrawing subsidies from insurance companies as soon as next month for those who participate in the state marketplaces? If it does, then that death will be significantly hastened. Second, if letting it die extends into 2018 then significant numbers of individuals will likely forego insurance do to its expense and the pressure on hospital operating budgets from the provision of un reimbursed care will begin to emerge. Third, state governments will then be under pressure to fill some of the gap as fiscal 2019 budgets are formed in the form of higher charity care subsidies to providers.

There is no doubt that the events of this week are positive for the two sectors. we just express caution over their staying power as positive drivers of credit performance over any extended period. For example, the  renewed effort at repeal would have ghastly consequences should it succeed. The CBO scoring of the latest iteration of repeal shows the number of people who are uninsured would increase by 17 million in 2018, compared with the number under current law. That number would increase to 27 million in 2020, after the elimination of the ACA’s expansion of eligibility for Medicaid and the elimination of subsidies for insurance purchased through the marketplaces established by the ACA, and then to 32 million in 2026.

Average premiums in the nongroup market (for individual policies purchased through the marketplaces or directly from insurers) would increase by roughly 25 percent—relative to projections under current law—in 2018. The increase would reach about 50 percent in 2020, and premiums would about double by 2026.

All of which would be negative for the state and hospital credit sectors.

MICHIGAN PENSION FUNDING

In his January 2017 State of the State address, Governor Rick Snyder announced the creation of a task force focused on addressing the unfunded pension and retiree health care liabilities of local governments in Michigan.  Of the approximately 1,800 local general purpose governments in Michigan, roughly one third provide post-retirement benefits. Due to a multitude of factors, many communities are now facing challenges funding the benefits to retirees. The total unfunded pension liability is estimated to be around $7.46 billion. The total unfunded liability for retiree health care is estimated at $10.13 billion. It is estimated that, for many Michigan cities, roughly 20 cents on the dollar goes to pay pension and OPEB costs.

the Task Force agreed on four main recommendations:  Greater reporting and transparency must be required of all local units to ensure a full understanding of the size and scope of the problem, and where the biggest challenges exist. This includes reporting using uniform assumptions to allow for better comparisons.  A pension and OPEB fiscal stress test system for local governments should be created to alert and assist local units in crafting solutions to best position them to continue to serve their residents, while funding their obligations and protecting benefits for employees and retirees. This system should identify and focus action on the local units experiencing the greatest fiscal stress.  This system, along with the creation of a new Municipal Stability Board (MSB), should assist in the review of a local unit’s finances and the development of a corrective action plan. The MSB should also provide research, training and technical assistance.  In addition to meeting existing constitutional and statutory requirements to pay pension costs, going forward all local governments should meet a minimum requirement to pay OPEB normal costs for new hires (i.e., to prefund new active employee’s current year obligation), if offered.

there were a few key issues for which there was fundamental disagreement:  Some Task Force members were opposed to the establishment of new funding requirements, concerned it would have too severe an impact on the local government’s ability to provide current services. While they recognized these liabilities as important, they maintained that the focus should be on making benefits more affordable and having adequate cash flow to maintain current services.  A majority of Task Force members were opposed to the establishment of plan design requirements for all local governments, believing that the local unit, through the collective bargaining process, should have the flexibility to agree upon what works best within their communities.  While the Task Force agreed to the concept of a MSB, it could not agree on the powers it would have. A majority of the Task Force members felt that the MSB’s role should be limited to making recommendations and providing technical support. A minority thought the MSB should be able to unilaterally impose changes if the local unit was unable to successfully implement a corrective action plan.

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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