Muni Credit News November 19, 2015

Joseph Krist

Municipal Credit Consultant


U.S. Senate Judiciary Committee Chairman Chuck Grassley said that he will convene a hearing on Puerto Rico’s fiscal situation on Tuesday, Dec. 1, at 10 a.m. Grassley said his goal is to help committee members and the public identify and gain a better understanding of the root cause of Puerto Rico’s fiscal problems, discuss what’s currently being done, and consider what options are available that could help Puerto Rico get itself out of the present situation.

The Judiciary Committee has jurisdiction over bankruptcy policy, which the commonwealth has implemented efforts to be included in, but Grassley has reiterated that restructuring debt and throwing taxpayer money at the island, without ensuring the creation and implementation of structural and fiscal reform, fails to resolve the underlying problems in Puerto Rico required to create economic growth. Witnesses for the hearing will be announced at a later date.

In the meantime, PREPA announced that it has executed an amendment to its previously announced restructuring support agreement (“RSA”) with the Ad Hoc Group of PREPA bondholders, comprising traditional municipal bond investors and hedge funds, its fuel line lenders and the Government Development Bank for Puerto Rico. The amendment extends the deadline for PREPA to reach an agreement with the monoline bond insurers on a consensual recovery plan to November 20, 2015. PREPA will use the extension to continue discussions with its monoline bond insurers, while the legislative process to approve the PREPA Revitalization Act continues.

Puerto Rico Senate President Eduardo Bhatia Gautier said it will be hard to pass the energy bill presented on Nov. 4 to restructure the island’s energy sector by the current deadline of the end of Thursday. If it is not approved by then, the governor will ask for an extraordinary legislative session to handle the matter, he said. The extraordinary session could be either in November or in December.

Gov. Alejandro García Padilla said if bondholders don’t agree to new terms on their debt, he will choose to pay for the needs of the people before paying the commonwealth’s creditors. The governor said that he has called for negotiations with bondholders, proposed a five year plan, and is working to assure future responsible Puerto Rico policies, according to a government transcript. Referring to the bondholders, he said, “If you don’t negotiate and I am obligated to choose between the creditors and the Puerto Rican people, I’m going to pay the Puerto Ricans.”

The government has said it is running low on money. There have been locally-based news stories about talk of a partial government closure or a cut of Christmas bonuses for government workers to deal with the financial crisis. “We are evaluating all of the mechanisms, like we said before, to avoid reducing the workday, government shutdown or stopping payments on the debt,” García Padilla said, according to the government. “What [Government Development Bank for Puerto Rico President] Melba Acosta, [Secretary of the Treasury Juan] Zaragoza, and [Office of Management and Budget Director] Luis Cruz all said is what the numbers say. If we don’t come up with extraordinary mechanisms, uncommon and abnormal in the government, those things, like partial shutdown, workday reduction, etcetera can happen.”

If the governor chose to allow a default and use government’s revenues for other purposes, it may put him at odds with Section 8 of Puerto Rico’s constitution, which states: “In case the available revenues including surplus for any fiscal year are insufficient to meet the appropriations made for that year, interest on the public debt and amortization thereof shall first be paid, and other disbursements shall thereafter be made in accordance with the order of priorities established by law.”

Acosta seemed to present a different approach to the government’s impending debt payments. In testimony to a joint hearing of two Puerto Rico House of Representatives committees, she said the payment of debts on Dec. 1 and Jan. 1 have the highest priority for payment, according to the El Nuevo Día news web site. Puerto Rico’s GDB owes $354 million in debt on Dec. 1. According to Moody’s, $273 million of this sum has a constitutional guarantee and $81 million does not. Puerto Rico also owes $330 million in general obligation debt Jan. 1.

Acosta told the legislators that the government is likely to make the Dec. 1 payment, according to El Nuevo Día. The debt is insured, she said. She said that the government was in talks to make the payment but did not further explain the talks. Moody’s however released a short report saying it thought a default on at least some of the Dec. 1 debt service was likely.

At the hearing House President Jaime Perelló Borrás said that the government should prioritize remaining fully open and paying Christmas bonuses and delayed tax refunds and supplier bills before the bond debt. Perelló Borras is in the same party as the governor, the Popular Democratic Party. Not making the December and January bond payments would lead to further major complications, Acosta said, according to El Nuevo Día. Acosta also said the government would present a proposal for restructuring the debt to the bondholders as we go to press.


The Illinois Finance Authority passed a resolution to ask its Board to provide the Executive Director, and 23 relevant staff with Authority, to use the State Procurement Code to explore the market to see if there will be any lenders that will, in essence, loan the Illinois Finance Authority money so that it may be of assistance, in connection with paying state bills, in connection with the state budget  impasse. Illinois Finance Authority was among a large number of state agencies that were asked to explore options. The resolution points to three statutory powers that the General Assembly  has provided to IFA: Statutory lien, statutory  non-impairment, and the statutory authority to provide up to around $100,000,000 in moral  obligation debt, which was a  form of statutory taxpayer guarantee.

The resolution would authorize an emergency purchase under the procurement code to competitively select and enter into contracts with necessary parties, including but not limited to lenders, underwriters, trustees or paying agents, servicers, printers, road show providers, and/or rating agencies, to finance one or more projects authorized under the Illinois Finance Authority act, including public purpose projects, the proceeds of which will be used to address one or more of the following in the absence of an enacted appropriation for fiscal year 2016, a court order or a consent decree: (i) threat(s) to public health or public safety, (ii) if immediate expenditure is necessary for repairs to state property in order to protect against further loss or damage to state property, (iii) to prevent or minimize serious disruption of critical state services that affect health, safety, or collection of substantial state revenues, or (iv) to ensure the integrity of state records; and other matters related thereto adopted.

In plain English, the Authority would borrow money to pay state bills which could not otherwise be paid without adoption of a state budget. It is yet another sign of the dire straits in which Illinois finds its credit position.


On November 10, 2015, Moody’s released a scenario analysis of the City of Chicago’s (Ba1 negative) possible pension funding paths. The scenarios incorporate the city’s recently adopted property tax increase as well as the outcomes of two key decisions pending with the State of Illinois and the Illinois Supreme Court. The analysis indicates that, despite significantly increasing its contributions to its pension plans, Chicago’s unfunded pension liabilities could grow, at a minimum, for another ten years.

“Chicago’s statutory pension contributions will remain insufficient to arrest growth in unfunded pension liabilities for many years under each scenario,” Moody’s says in the new report.” The scenario that Moody’s views as having the most positive credit impact for Chicago consists of a favorable Illinois Supreme Court decision, as the city’s budget assumes, but state legislative action that does not conform to the city’s adopted plan. Senate Bill 777 has been passed by the Illinois General Assembly, but requires the governor’s approval to become law. The bill lowers Chicago’s current statutory public safety pension contributions relative to existing statute, granting the city more time to meet statutory funding targets. Without Senate Bill 777, the city’s 2016 statutory pension contribution will be much higher than the city has budgeted.

“This scenario is the most credit positive over the long term. Although it would require larger pension contributions than currently budgeted, the higher payments would achieve the slowest and least extensive growth in unfunded liabilities among the four scenarios,” Moody’s says.

The city’s adopted budget assumes the governor signs Senate Bill 777 and the Illinois Supreme Court reinstates PA 98-0641, the latter of which would preserve benefit reform of Municipal and Laborer pensions and reduce the plans’ risk of insolvency. While the adopted budget notably increases the city’s pension contributions relative to prior years, the amounts contributed under these assumptions could enable unfunded pension liabilities to grow for up to 20 years.

Two other scenarios assume an unfavorable ruling from the Illinois Supreme Court, which would raise the possibility of substantial cost growth for the city over the next decade, with or without Senate Bill 777. “This would exert additional negative credit pressure on Chicago’s credit quality because it would likely remove all flexibility to reduce unfunded liabilities through benefit reform and raise the probability of plan insolvency,” says Moody’s.


With the debt crisis in Puerto Rico about to come to a head, many references are made to the NYC financial crisis which this month marks its 40th anniversary. A seminal event in the history of the municipal bond market, it opened an era of regulation, disclosure, and reform that continues to this day. It can be said to have led to improved (not perfect) financial disclosures and practices and spawned a generation of municipal analysts who expected and demanded a more transparent credit environment on behalf of all segments of the market. It is easy to forget how bad the situation was and how much was accomplished over the following four decades.

New York City faced a significant fiscal crisis and effectively defaulted in 1975 because it had literally run out of money and could not pay for normal operating expenses. Timely state and federal action saved the city from defaulting on its obligations and possible bankruptcy. At the time, New York City and its subdivisions had $14 billion of debt outstanding of which almost $6 billion was short-term. The city admitted to an operating deficit of at least $600 million, although modern  accounting methods would have produced a deficit of something along the lines of $2.2 billion. The city was effectively shut out from credit markets.

The city had used obsolete and confusing budgeting and accounting gimmicks for over a decade including: overly optimistic forecasts of revenues, reliance on revenue anticipation notes, including notes for revenues that did not materialize, underfunding of pensions, use of funds raised for capital expenditures for operating costs, and the appropriation of illusory fund balances, meaning that special fund revenues were overestimated and used to balance the budget. Finally in February 1975 a sale of tax anticipation notes was canceled when the underwriter backed out. In the meantime, banks began selling their own holdings of city securities.

In March of 1975, underwriters were growing more and more resistant to working with the city on any more debt issuance.  Bond counsel would not issue a clean opinion on a sale, which was necessary for reselling the notes and bonds  and doubts had arisen that bondholders could exercise their first lien on city revenues. Then, the New York State Urban Development Corporation defaulted on some bond anticipation notes. Although the corporation was separate from the city, the projects of the corporation were in the city. Investor concerns grew when the legislature made sure that the suppliers and contractors were paid but not the bondholders (the infamous moratorium).

The city attempted to move debt off its own balance sheet and stretch out their maturity through a separate corporation, the Stabilization Reserve Corporation, to hold the city’s debt. This move was challenged as an unconstitutional attempt to get around the City’s statutory debt limit. The city was forced to drop the plan. By April 1975, the city was out of money. After lengthy negotiations, underwriters agreed to underwrite more securities provided that the city adopted sound accounting principles, admitted that it had large operating deficits, and ended its budget ploys, including the practice of phony forecasts of revenues. But the City resisted.

The Municipal Assistance Corporation (MAC) was an independent corporation authorized to sell bonds to meet the borrowing needs of the city. MAC was a creation and entity of the state. The majority of appointees on the Corporation’s Board were made by the Governor. As part of the creation of MAC, the state passed legislation that converted the city’s sales and stock transfer taxes into state taxes. These taxes were then used as security for the MAC bonds without ever passing through to the city. Besides creating the MAC, the state also advanced additional funds. The state prepaid state aid that the city was scheduled to get during the fiscal year, in an attempt to keep the city afloat. The MAC demanded that the city institute a wage freeze, lay off employees, increase subway fares, and begin charging tuition at city universities. Despite a summer of labor unrest, these measures stuck and MAC was able to refinance some city debt.

The Emergency Financial Control Board (EFCB) was created in September during a special legislative session. It was analogous to putting the city into receivership. The EFCB had authority over the finances of the city. It could control the city’s bank accounts, issue orders to city officials, remove them from office, and press charges against city officials. The Governor made the majority of appointments to the Board. The state law creating the EFCB required the city to balance its budget within three years, change its accounting, and submit a three-year financial plan. The Board had the power to review and reject the city’s financial plan, operating and capital budgets, contracts negotiated with the public employees unions, and all municipal borrowing. Besides creation of the control board,  a deputy state comptroller was appointed to audit city books. The Mayor’s Management Advisory Board California Research Bureau, was created and staffed by business representatives to advise the mayor on management practices. The temporary Commission on City Finances was established to analyze, criticize, and recommend changes in the city’s long-range taxation and expenditures policies.

Only after all of this did the City receive assistance from the Federal Government. In November of 1975. Federal legislation extending up to $2.3 billion of short-term loans to the city was passed. The House of Representatives passed the aid package by a 10 vote margin. The city was forced to hike fees for services, especially for the city university and the subway. Other services were cut. The city’s work force was trimmed and a wage increase was rescinded. Up to 40 percent of the assets of the city pension fund were invested in MAC securities. The state pension fund also invested in MAC securities. A total of $2.7 billion of city debt was bought by the pension funds.

The banks who had served as the underwriters for New York’s securities agreed to purchase additional securities and/or lengthen the maturity or lower the interest rate on the securities that they held. Other holders of securities had to exchange them for ten-year MAC securities or face a three-year moratorium on the repayment of principal on the notes. The banks turned in $819 million in notes for MAC debt and restructured the interest and maturities of the other debt they held. The budget had to be balanced using generally accepted accounting principles. Most notable of these were the elimination of financing operations from capital funds and a requirement that the city fully fund its pension plans. The First Deputy Mayor, Deputy Mayor for Finance, and the budget director all had to resign so that trustworthy staff could be appointed. The federal loans were made at 1 percentage point over the cost of funds to the federal government.

The city kept its part of the bargain in dealing with public employees. City employment fell by 20 percent and work rules were loosened. Wages were reduced and eventual raises were held below the level of inflation. By 1977-78, the city had no short-term debt. As part of its obligation imposed by the federal government, the state assumed the full cost of financing the city university system (leading to the imposition of tuition) and a portion of welfare and court systems. The state also tightened controls over Medicaid reimbursements to health care providers.

This history is something to keep in mind as the market deals with Puerto Rico. These steps outlined above were painful for the City and its residents over a long time period. Puerto Rico would be wise to understand this history as its continues to demand a relatively pain-free exit from its own legacy of irresponsibility and mismanagement. Talk of prioritizing things like Christmas bonuses ahead of debt service shows a fundamental lack of maturity and seriousness on the part of the Commonwealth’s political leadership. The use of inflammatory rhetoric like that of the Commonwealth’s representative to Congress this week in which he likens the requirement for a federal control board to colonialism would be laughable if it were not so sad. If Puerto Rico does not want to be treated as the equivalent of a financial child, it needs to grow up an act like a financial adult.

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