Muni Credit News June 25, 2015

Joseph Krist

Municipal Credit Consultant


Thirty six municipal bond underwriters operating in the $3.7 trillion muni market will collectively pay about $9 million to settle civil charges over fraudulent offerings, as part of the first settlement of its kind with the U.S. Securities and Exchange Commission. The SEC said that the charges stemmed from a March 2014 invitation to brokers and bond issuers to voluntarily report disclosure violations in offering documents, such as material misstatements and omissions.

The firms represented about 70 percent of the dollar value of all municipal bonds issued in the United States during the four years ended on Sept. 30. The settlement requires each firm to pay civil penalties based on the number and size of the fraudulent offering. The maximum penalty is $500,000 for large firms and $100,000 for smaller ones. The firms also must hire independent consultants to review their policies and procedures.


With PR fast approaching its July 1 fiscal cliff, Governor Alejandro García Padilla confirmed that his administration recently pursued a proposal to request that the U.S. Congress allow the Puerto Rico government to declare bankruptcy. García Padilla said he has since rejected the proposal in favor of a current effort to get rules that would allow only Puerto Rico’s public agencies to file for bankruptcy under Chapter 9.  A U.S. House committee is studying the issue amid growing concerns about the government’s ability to repay its debt and is holding hearings this week.

Pedro Pierluisi, Puerto Rico’s representative in Congress, criticized García Padilla for pursuing such a proposal privately. The Government Development Bank has warned that the government could have to shut down in the coming months if new measures to generate revenue are not enacted. García Padilla recently signed a bill to increase the sales and use tax (IVU by its Spanish acronym) from 7% to 11.5% and to create a new 4% tax on professional services. The sales tax increase goes into effect July 1 and the new services tax on Oct. 1, with a transition to a value-added tax by April 1.

Legislators are now debating a proposed $9.8 billion budget which includes $674 million in cuts and sets aside $1.5 billion to help pay off Puerto Rico’s debt. The budget has to be approved by June 30. In the meantime, Senate Bill 1350, which aims to enhance oversight powers and immunity protections for Government Development Bank (GDB) officials now moves to the governor’s desk after a conference committee version was approved by the Legislature.

The bill keeps immunity language, which stipulates that GDB directors, officers and employees “shall be indemnified by the bank and shall not have any personal civil liability to any entity for actions taken or not taken in good faith in their capacity and authority, absent clear and convincing proof or gross negligence comprising reckless disregard of, and failure to perform, applicable duties”. The bill also calls for the Senate’s approval of GDB directors appointed by the executive branch, beginning in January 2018.

It keeps provisions for the creation of the Audit and Risk Management committees, and places lending restrictions on loans provided by the GDB. The bank would be empowered to require from public corporations and instrumentalities access to any financial information and related documents it deems necessary, with sanctions established for noncompliance. The GDB would also be allowed to pass judgment on the “reasonability” of the government revenue estimates for each fiscal year.

The bill includes provisions requiring the bank’s president to submit a monthly report on new loans to the legislature, as well as amendments to existing ones approved by the bank’s board; appear once a year at both chambers to present the bank’s annual report on public debt; and submit both the Commonwealth’s Financial Information & Operating Data Report and Quarterly Reports within five days of publishing them. The bill also creates a Commission for the Integral Audit of Public Credit with broad powers to analyze and audit everything related to Puerto Rico’s public debt. It would act autonomously, and would comprise members from both public and private sectors, as well as academia.

Many of S.B. 1350’s original provisions, including those allowing for the appointment of emergency managers for troubled public corporations and instrumentalities, and the transfer of deposits from municipalities and the University of Puerto Rico (UPR) to the GDB were eliminated in order to secure the necessary votes for passage in both chambers.

To address the Government Development Bank’s liquidity,  a bill that seeks to raise short-term debt from some public corporations, as well as requiring reserves to cover general-obligation (GO) debt, was approved late Tuesday by the House. House Bill 2542 now moves to the Senate, which would have to consider it before Thursday, the last day for both chambers to approve measures during this session, while bills at conference committees have until June 30.

Amendments to the measure include provisions allowing the Treasury Secretary to “suspend, totally or partially” monthly deposits made to cover principal and interest payments on GO debt, if it fails to either secure $1.2 billion in tax & revenue anticipation notes (TRANs), or at least $2 billion in a bond deal backed by the latest hike to the petroleum-products tax.  The House-approved bill also requires the Office of Management & Budget (OMB) to reserve $250 million in the proposed fiscal 2016 budget, which would bring it down to $9.55 billion from the initially projected $9.8 billion, he indicated.

The bill would allow use of about $400 million for TRANs from investment funds of the Automobile Accidents Compensation Administration (ACAA), Temporary Nonoccupational Incapacity Insurance (Sinot) and State Insurance Fund (SIF). While Sinot and ACAA would provide $15 million and $50 million, respectively, SIF’s share stands to total about $335 million. The bill adds that these investments would still be carried out, regardless of the credit rating of the instrument or any restriction placed by the public corporations’ investment policies or contractual obligations.

During the House debate, the minority leader declared ominously, “we are telling bondholders that if you want certainty, invest first in Puerto Rico,” adding, “We will pay the GOs, but we have to restructure the rest of the debt.”

Under a scenario in which the government can’t accomplish any of two financing plans, the minority leader stated that with the “combination of the $400 million from the public corporations, the additional 4.5% to the sales tax, and not doing the monthly reserves for GOs, we would keep the government operating.”

Government officials have previously said that absent TRANs or short-term financing at the beginning of the fiscal year, Treasury could potentially run out of cash during the first quarter, which would affect government operations and services, as well as exacerbate the island’s economic and fiscal crisis. Several options are under consideration—including the exchange of short-term notes worth as much as $4 billion—as it pursues a parallel initiative with the U.S. Treasury Department. The GDB’s net liquidity position was $778 million, as of May 31.  It has been reported  that Puerto Rico’s government has lobbied the U.S. Treasury to purchase GDB notes in a last-resort effort to increase much-needed liquidity.

Meanwhile, as a significant July 1 principal payment looms, Puerto Rico Electric Power Authority (PREPA) and its creditors entered into yet another forbearance agreement extension, until June 30, while they continue to negotiate a restructuring plan for the financially troubled utility that prevent a potential default and court-mandated receivership. Bond insurers would have to cover much of the July 1 payment, if PREPA were to miss it. In a recent filing, U.S. Bank N.A. PREPA’s trustee, indicates that it doesn’t hold sufficient funds or investments to cover the July 1 payment, adding that no deposits have been made by PREPA to the trustee since March 31.

It said that “in advance of the July 1, 2015, bond payment date, the trustee may be required to liquidate investment obligations held in the reserve account, including substantial long-term government obligations.” Failure to extend the forbearance protection before agreeing on a restructuring deal would virtually allow creditors to ask the court to oversee the utility’s overhaul by placing a receiver in charge of the process if PREPA were to default on any of its debt obligations. Under that scenario, a default notice would be issued by the trustee, which would give PREPA 30 days to address the issue. Failure to do so would result in an event of default, allowing creditors to take the matters to court.

The net take-away is that PR well deserves a mid or lower range CCC rating. Only Moody’s has gone down that far. We think that the B and CCC+ ratings from Fitch and S&P are still too generous.


Sweet Briar College, the women’s liberal arts college in rural Virginia that announced it would close in August — setting off protests and lawsuits from students, faculty and alumnae — will remain open for at least one more academic year under an agreement announced Saturday by the attorney general of Virginia. The AG said the agreement, which includes plans for electing a new president and board, and calls for an alumnae group to donate $12 million for Sweet Briar’s continuing operations. The agreement also calls for the easing of restrictions on $16 million from the college’s $85 million endowment — money that, combined with the $12 million from alumnae, will help keep the school open. The alumnae group has agreed to deliver the first $2.5 million of its donation by July 2.

A judge in Amherst County, Va., whose county attorney sued to keep Sweet Briar open, approved the settlement on Monday. Away from the obvious issues – the conversion of pledged donations to hard cash, recruitment of a freshman class mid-summer, and an effort to repatriate students, faculty and employees who had  been told to leave, many of whom have already made plans to attend other schools – the decision raises real questions for debt holders. The closure plan provided for the full redemption of the school’s outstanding bonds. While the call could be seen as premature, redemption would have provided full payment and relieved the bondholders of the principal risk associated with a weak credit. Now there has been no call, and without a long-term plan, bondholders remain in limbo with potentially $16 million less in endowment assets available.

Under the memorandum of understanding released by the attorney general, 13 of Sweet Briar’s 23 board members will be replaced by at least 18 new elected members. The new board, the memorandum said, is expected to appoint Phillip C. Stone, a former president of Bridgewater College, a small private college in Virginia, to serve as the new president of Sweet Briar. The agreement also calls for the attorney general to ease restrictions on $16 million from the college’s $85 million endowment — money that, combined with the $12 million from alumnae, would finance operations.

Sweet Briar was founded in 1901 by a wealthy Virginia landowner, who bequeathed her entire estate — a former plantation — for the express purpose of educating young women. How much demand there is for a school best known for its equestrian programs is unknown. Enrollment has been in decline for some time. Fifty years ago, there were 230 women’s colleges in the United States; last year there were 46.

The fact that the school will remain open does nothing to improve the credit from a rating standpoint. The existing S&P CCC is well deserved.

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