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.

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