Muni Credit News May 12, 2016

Joseph Krist

Municipal Credit Consultant

PR BUDGET YET TO BE ISSUED AS IT ARGUES FOR CREDIBILITY

One can understand that the administration of the Commonwealth might be overwhelmed by simultaneous efforts to mange scarce resources, lobby Congress for fiscal assistance, and negotiate a debt restructuring with a variety of creditors. At the same time it is difficult to see the Commonwealth as a credible partner in the current crisis when Gov. Alejandro García Padilla has yet to present a budget as he waits for the U.S. Congress to approve debt-restructuring and other economic-development mechanisms for Puerto Rico. When he says “the budget is being worked on responsibly and comprehensively to allow for the continuation of services to citizens”, we feel that we have heard this song before.

Senate President Eduardo Bhatia said Tuesday that the budget “is very late; I’m not happy. I know it’s a difficult time, but we have to have three scenarios,” which he explained as a budget “with the payment of debt, another without its payment and a third one with only the payment of the debt’s interest.” “If these aren’t available soon, it’s impossible as a legislature to fulfill our constitutional duty.” He also reminded the parties that  “it is the latest in history to receive a budget.”

Clearly it would be easier to formulate a budget with at least the framework for a potential “bailout” (yes, we said it) to be available but, this is just another fiscal management failure by the current administration. It is not a matter of whether significant expense cuts need to be made, but how and where. We don’t see evidence of the obviously needed process of triage that will accompany any near term financial resolution. The continued brinksmanship and lobbying being relied upon by the current administration simply is not useful.

We will see how effective the lobbying effort will be. Gov. Alejandro García Padilla met Wednesday with House Speaker Paul Ryan (R-Wis.), Natural Resources Committee Chairman Rob Bishop (R-Utah) and House Minority Whip Steny Hoyer (D-), according to a statement released by La Fortaleza. He also held talks with Reps. Sean Duffy (R-Wis.), who is sponsoring Promesa, Raúl Labrador (R-Idaho) and Charles Dent (R-Pa.). The expected release of a revised Puerto Rico Oversight, Management & Economic Stability Act was delayed due to continued discussions in committee. The stumbling blocks continue to be reducing minimum wage, failing to protect pensioners and doing away with overtime rules.

Meanwhile, the bond-purchase agreement between the Puerto Rico Electric Power Authority, a group of bondholders and bond-insurance companies will expire Thursday unless the creditors give PREPA $111 million or the pact is extended. The agreement is part of PREPA’s larger debt restructuring deal. Puerto Rico lawmakers passed a debt moratorium in April that allows Governor Alejandro Garcia Padilla to skip debt-service payments on all island debt. PREPA’s creditors are reluctant to lend the utility more money unless Puerto Rico lawmakers amend the moratorium law to exempt PREPA.

PREPA’s position is that “conditions required for creditors to fund the $111 million bond purchase under PREPA’s restructuring support agreement and related documents have been satisfied, and as a result such creditors are required to fund the $111 million bond purchase on May 12, 2016,” the utility said in the statement. “PREPA paid $111 million in interest to these creditors in January 2016 in reliance on the creditors’ agreement to re-lend the same amount if two important milestones in PREPA’s restructuring occurred.” The obligation of creditors to buy the three-year bonds is subject to several conditions being fully satisfied, including that no Puerto Rico statue enacted after the agreement shall have an adverse affect on the rights and remedies of the 2016 bonds or their validity or enforceability. Obviously, something has to give.

On another front the Commonwealth’s credibility was under attack this week when Ambac sued the Puerto Rico Highways & Transportation Authority (HTA) on federal court on Tuesday that calls for the appointment of a receiver for the Authority. Ambac’s argument is that the HTA has failed to meet its fiduciary and contractual duties to its creditors. It cites the “suspect timing” during which HTA and Metropistas, a local subsidiary of Spanish firm Abertis, recently agreed to extend the concession contract of PR-22 and PR-5 for $115 million, of which $100 million has been already disbursed.

It is not challenging the contract itself. Instead, Ambac is focused on the use of the funds, arguing these “would likely be siphoned off by the commonwealth government” for purposes not related to HTA. This suit follows suits filed earlier this year by Ambac and Assured Guaranty, challenging the redirection of pledged revenues, known as “clawbacks,” to pay for public debt, a move the monolines deem as illegal and invalid under the U.S. Constitution. Gov. Alejandro Garcia Padilla’s clawback order covers one of HTA’s revenue sources for the repayment of its debt.

WHAT MAKES AN ISSUE TAXABLE

We’ve always taken an interest in what makes a tax-exempt bond taxable. The latest case involves a California authority and a high school district which announced  this week that they are prepared to file a protest and appeal of an expected Internal Revenue Service proposed adverse determination that $25.4 million of tax-exempt variable rate demand bonds are taxable.

The California Statewide Communities Development Authority and the Sweetwater Union High School District  have received a “Notice of Proposed Issue” in which the IRS tax-exempt bond office asserted that the 2005 bonds are taxable private-activity bonds.

“”If TEB issues a proposed adverse determination, the authority and the district will respond by filing a protest, including a request for view of the [IRS] Office of Appeals.”

Typically, cases handled by the appeals office result in out-of-court settlements.

The case revolves around an unusual conduit structure used to address concerns about state laws. The authority issued $25.4 million of tax-exempt variable rate demand revenue bonds and $8.2 million of taxable variable rate bonds in February 2005. The proceeds were lent to Plan Nine Partners, LLC, a subsidiary of California Trust for Public Schools, a nonprofit that helps expedite land acquisitions for public schools, according to group’s Form 990 tax form.

The proceeds funded the purchase a 23.82 acre parcel of industrial mixed-use land located Chula Vista, Calif. Plan Nine Partners were to lease the land to the Sweetwater school district, which wanted to build a new administrative headquarters, academic buildings and a bus yard on about 73% of it. The official statement estimated that some  $120 million of additional bonds would be needed to finance the development of those projects. It does not appear those bonds were issued. The land was to be held in the name of Plan Nine Partners until the bonds were paid off in 30 years and was to then be conveyed to Sweetwater in an exchange agreement. The district would pay rent equal to the bond debt service to Plan Nine Partners.

The IRS began an audit in September 2013, and issued an information document request in October 2014. The authority and Sweetwater responded to the IDR in January 2015, arguing the tax-exempt bonds issued were not taxable. TEB filed a Notice of Proposed Issue on January 26 again asserting the bonds were taxable PABs.

Under the federal tax code, at least 95% of the proceeds of 501(c)(3) bonds must be used for “good” or non-private purposes. About 27% of the land was to be used for development and sale for private business use, the OS stated.

“The authority and the district still disagree with the IRS analysis and its conclusion.

ONE WAY TO DEAL WITH THE IRS

The Indianapolis Airport Authority (the “Authority”) is providing voluntary notice that, in connection with a random examination of its 2006 F Bonds which were purchased by the Indianapolis Local Public Improvement Bond Bank with proceeds of a $346 million of bonds issued by the Bond Bank. The Internal Revenue Service’s Field Office has asserted a rebate liability with respect to the Bonds. Although the Authority disagrees with and has opposed the Field Office’s position, the Authority and the Internal Revenue Service have agreed to a settlement of the dispute that will close the examination with no change to the tax exempt status of the Bonds.

This is how a large number of these disputes are settled. While upsetting to holders, the IRS has stated that it typically is not its goal to penalize individual holders of bonds. Rather, it seeks to come to some financial arrangement with the issuer of a contested issue.

SEC CONTINUES ENFORCEMENT ALONG WITH CRIMINALCHARGES

The Securities and Exchange Commission today charged a father and son and five associates with defrauding investors in sham Native American tribal bonds in order to steal millions of dollars in proceeds for their own extravagant expenses and criminal defense costs. The SEC alleges that Jason Galanis conducted the scheme in which the “primary objective is to get us a source of discretionary liquidity,” he wrote in an e-mail to other participants.  Galanis and his father John Galanis convinced a Native American tribal corporation affiliated with the Wakpamni District of the Oglala Sioux Nation to issue limited recourse bonds that the father-and-son had already structured.  Galanis then acquired two investment advisory firms and installed officers to arrange the purchase of $43 million in bonds using clients’ funds.

The SEC further alleges that instead of investing bond proceeds as promised in annuities to benefit the tribal corporation and generate sufficient income to repay bondholders, the money wound up in a bank account in Florida belonging to a company controlled by Jason Galanis and his associates.  Among their alleged misuses of the misappropriated funds were luxury purchases at such retailers as Valentino, Yves Saint Laurent, Barneys, Prada, and Gucci.  Investor money also was diverted to pay attorneys representing Jason and John Galanis in a criminal case brought parallel to the SEC’s stock fraud charges last year.

In addition five other individuals were charged with violations of the antifraud provisions of the federal securities laws and related rules.  The SEC seeks disgorgement plus interest and penalties as well as permanent injunctions.  In a parallel action, the U.S. Attorney’s Office for the Southern District of New York today announced criminal charges against the same seven individuals.

This continues the emerging strategy of stronger enforcement of civil  regulations backstopped by criminal actions in order to increase the deterrent effect against bad actors in the municipal space.

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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