Muni Credit News March 3, 2016

Joseph Krist

Municipal Credit Consultant


A draft, obtained by The New York Times, indicates that the Treasury Department is putting forth a plan to address Puerto Rico’s financial crisis which would put pension payments to retirees ahead of payments to bondholders. This would be a huge change for our market. The establishment of such a move which would be highly detrimental to bondholders has long been sought by public employees and their advocates. It would also seem to override prime provisions of the Puerto Rico Constitution which have long been relied upon to offset the irresponsibility of the Puerto Rico political establishment.

“The major problem is, the entire pension system is close to being depleted,” said Antonio Weiss, counselor to Jacob J. Lew, the Treasury secretary. “But 330,000 people depend on it. It’s unfunded, and they have to be protected.” Weiss has previously been the Treasury’s point man for advocating positions negative to bondholders. Shielding retirees from pension cuts, the thinking goes, would not only protect thousands of older residents on the island, but it might also encourage younger retirees to stay there, rather than move to the United States mainland in search of new jobs and incomes.

Out-migration is considered a prime cause of Puerto Rico’s financial decline, because it shrinks the island’s economy, leaving fewer people and fewer dollars to support debt. That out migration has been seen greatly among those population cohorts which are best positioned to support an economy over the long term. These are non-public employees or those (like nurses and doctors and financial professionals) for whom private opportunities on the U.S. mainland will continue to be better than what is available on the island.

But deciding that pensioners’ interests should be put above those of bondholders — if a choice must be made — is not without certain risks. If Puerto Rico can renege on promises to pay debts to investors, while sparing retirees, other municipalities might try to do the same. While it would be “special treatment” for Puerto Rico there huge contagion risk to the entire  municipal market.   Issuers where pensioners have constitutional protection, as is the case in Illinois, would likely cite such a resolution as a way out of their own similar pension funding problems. The Treasury contends that such concerns are unfounded. The framework they are proposing would be designed only for distressed United States territories, like Puerto Rico, and could not be used by states or municipalities on the mainland.

The problem is that once established, it would be hard to limit the precedent set. We disagree with the notion that most institutional investors understand Puerto Rico’s unique situation and the coming debt restructuring will not create widespread credit implications. Moving public pensions to the top of the flow of funds would greatly upset bondholders — especially those who paid close to face value for their bonds years ago, when they were still rated investment grade, and who had expected to hold them to maturity and get all their principal back.

Although the Puerto Rico government has sought to portray the bondholders as deep-pocketed vultures since Puerto Rico’s debt crisis began, many of them are small investors, themselves trying to save for a comfortable retirement. Many are over 65, and they mostly have incomes of less than $100,000 a year. They are not vulture funds. They are regular individuals. This reflects the above average yields and interest that was exempt from federal, state and local taxes, no matter where the buyer lived.

A version of Treasury’s plan was outlined in a draft bill presented to a Senate committee; it has not been voted on. The draft document also is said to call for a five-member “fiscal reform assistance council” appointed by the president to hold the island to meaningful budgeting, disclosure and fiscal reform practices. The board would have the power to make across-the-board budget cuts if necessary.

Currently, Puerto Rico’s laws and Constitution give top priority to general-obligation bonds — the type backed by the government’s “good faith, credit and taxing power.” In general, its bonds can be ranked in a hierarchy of eight levels, with general-obligation bonds at the top. The ranking is described in according to an analysis of the debt by the Center for a New Economy, a nonpartisan research group in San Juan. Public workers’ pensions, the center found, fall on a second hierarchy altogether, which sets priorities for the government’s operational disbursements. Here again, however, payments due on general-obligation bonds come first, followed by payments due on legally binding contracts. Outlays for pensions come third.

The Treasury’s proposed restructuring framework would change that. It would require that the restructuring plan “not unduly impair the claims of any class of pensioners.” General-obligation bondholders, on the other hand, would get such protection only “if feasible,” according to the draft that outlined the plan.


Puerto Rico will run out of cash to meet the more than $2.5 billion in debt-service payments it owes this summer, beginning with $422 million due May 2 by the cash-strapped GDB. After putting forth earlier this year a voluntary debt-restructuring offer to creditors, the administration is already “working to develop a counterproposal that is responsive to all of the creditor feedback but falls within the parameters of the commonwealth’s ability to pay,” according to a presentation made this week to investors. The exchange offer targets about $49 billion in “tax-supported debt,” including general obligations (GOs), Sales Tax Financing Corp. and various other public entities.

According to the  presentation given Tuesday by Puerto Rico officials during an investor event in Miami, Chapter 9 is now insufficient to tackle its problems. Among the reasons Chapter 9 won’t be enough for Puerto Rico, the officials mentioned it would fail to cover such credits as GOs, Cofina and pension systems. Commonwealth officials believe an effective process to restructure Puerto Rico’s tax-supported debt should be comprehensive enough to cover GOs, Cofina and pensions, while everything is done under one coordinated proceeding. It should provide for bringing holdouts onboard any deal potentially reached with a majority of creditors, while establishing access to interim funding through a process known as “debtor in possession” (DIP) financing, as well as a temporary stay on litigation. A fiscal oversight council — a commonwealth entity authorized and designed by federal statute — should also be established.

PR believes the plan should comprise an out-of-court process, whereby an overseeing federal court would first appoint a mediator in the restructuring talks between Puerto Rico and its creditors, amid a short-term litigation stay and DIP financing to finance government operations. If an acceptable deal is reached by the majority, the court would then make it binding on all creditors. If no accord is struck, an in-court proceeding similar to Chapter 9 would follow, although with the broadest definition of instrumentality and streamlined standards for eligibility.


For an example of why settlement of the Puerto Rico situation matters to others, one only has to look at Detroit just two years after its bankruptcy. Mayor Mike Duggan, heading into his 2016-17 budget presentation before the City Council last week, said that he’s concerned about the long-term impact of a $491-million pension shortfall that threatens to balloon payments to the city’s two pension funds in 2024.Duggan said there’s no question that extra tens of millions of dollars a year the city will have to pay to the pension funds could cut into reinvestment efforts aimed at improving critical city services such as public safety and blight removal.

The city is running ahead of budget for the year — with a projected $34- million surplus — that gives the city a cushion. Duggan planned to propose to the council that the city make an additional $10-million pension payment this year in 2016 to begin paying down the extra pension costs, which the city blames on mistaken actuarial assumptions used by consultants in Detroit’s landmark Chapter 9 bankruptcy. Detroit’s population decline is slowing, people are moving back into the city, and property values are rising significantly in a majority of Detroit’s neighborhoods. If that trend continues it will generate enough revenue in property taxes so that the city can pay to upgrade public services and meet its pension obligations.

The bankruptcy was supposed to have settled the city’s shortfalls in paying into the Police and Fire Retirement System and the General Retirement System, but an actuarial consultant for the pension plans now estimates the funds will be $491 million short, leading to higher payments than expected beginning in 2024. The consultant, Gabriel, Roeder, Smith, said bankruptcy consultants used outdated life expectancy tables — estimates on how long retirees will live to collect their pensions — in projecting the city’s total pension obligation.

Duggan said the city plans to manage the problem now with additional payments instead of dealing with a crisis in 2024. Detroit is now looking to hire a consultant to verify the pension plan shortfall and determine the best way to pay for it. The city ultimately may end up making even larger payments to cover the shortfall in 2017 and subsequent years, or continuing payments in years where the city’s long-term budget calls for lowering them.

“We’re just really disappointed  that we came out of bankruptcy having been told — and everybody was told in the grand bargain — the pension shortfall was solved, and now it appears it was not,” Duggan said. The grand bargain was the deal in which the State of Michigan, charitable foundations and the Detroit Institute of Arts pledged the equivalent of $816 million to reduce cuts to city pensioners in exchange for sparing the museum from having to sell art in Detroit’s bankruptcy.


The U.S. Supreme Court has declined to rule on a major case involving payments to New Jersey’s pension system for public employees. The case – Burgos v. State of New Jersey – concerned Governor Christie’s decision to cut billions of dollars in payments he had once promised for the retirement system. As a part of his plan to address New Jersey’s negative financial outlook, Governor Chris Christie signed legislation that was described as requiring the State to make increased annual payments to shore up the State’s woefully unfunded pension systems. As time went on and the State’s economic recovery lagged national trends, the State finances continued to be strained and its credit continued to be downgraded.  In order to balance the State’s budget in 2014, Christie began to cut those payments despite having signed those laws in his first term that pledged more than $16 billion over seven years for the troubled retirement system.

Public worker unions then sued, arguing that Christie and the state Legislature could not skip the higher payments. The New Jersey Supreme Court disagreed, ruling 5-2 that the seven-year plan was not legally binding. In an order issued Monday, the U.S. Supreme Court declined to review that decision. As is their custom, the justices did not give reasons for declining to hear the case. It is likely that they did not see a federal constitutional issue in the case which required their review. This means that the ruling by the New Jersey Supreme Court stands as the law.


Retired bankruptcy judge Steven Rhodes been named by Gov. Rick Snyder as the new transition leader for the district the district as it addresses the debt crisis in Detroit Public Schools. The District will need financial help from state lawmakers to provide the additional cash the district needs to reorganize and pay its debts — a necessity given the district is expected to run out of money this spring.

Snyder has backed legislation that calls on lawmakers to approve an additional $715 million in state funding to pay off the district’s $515-million operating deficit and fund the creation of a new debt-free district to educate Detroit children. But getting legislation through could be a difficult task. Lawmakers in the House and the Senate have introduced two very different packages of bills aimed at trying to fix the district.

Rhodes said his first priority will be to obtain accurate and complete, detailed cash-flow projections of what revenue and expenses will be, what they are projected to be through the end of the year. He said he plans to make that information available to the public. It  is troubling that once again a major municipal issuer is in financial trouble and that the information about its finances is not clear and available for a resolution to be quickly implemented.

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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