Muni Credit News November 24, 2015

Joseph Krist

Municipal Credit Consultant

Our usual Thursday posting time has been moved up this week to accommodate Thanksgiving. Enjoy the holiday and we will return to our regular schedule next week.


It came as no surprise when the Friday, Nov. 20, deadline on a restructuring deal struck two weeks ago for PREPA came and went. The tone of the debate over legislation necessary to implement a restructuring agreement for PREPA showed that not enough of the political establishment currently had the will to meet all of its requirements. The effort to achieve a relatively pain free result (pain free for both politicians and customers) continues. Fortunately, the cash-strapped Authority secured from its creditors an additional extension to the agreement’s drop-dead date, until Dec. 10, to get its monoline insurers on board.

Press accounts attributed to Chief Restructuring Officer Lisa Donahue said PREPA insurers were on the verge of joining an agreement. The creditors are said to have granted an extension until at least Dec. 4 and no later than Dec. 10 to grant adequate time to secure passage of the bill and to seal final details with the remaining monoline bond insurers. According to the RSA, if PREPA fails to reach an agreement with monolines that is acceptable to all parties, the implementation of a recovery plan for the utility would be worked “through a mechanism to be agreed among the Parties that may include, without limitation, a judicial process (including an enforcement proceeding under applicable law).”

PR Senate President Eduardo Bhatia has previously said majority lawmakers would seek to safeguard the interests of the commission, ensure that the proposed changes to the governance are in line with what they want and that payment to creditors is guaranteed. PREPA  has warned about introducing changes to the legislation that could jeopardize the restructuring agreement. Among the RSA’s requirements that must be met for the accord to hold, PREPA must also submit a rate-review proposal at the Puerto Rico Energy Commission (PREC) by Dec. 15. The commission also has its own set of deadlines it must meet in order to maintain full authority over the rate-review process. Failure to meet the RSA’s timetable could force the utility back to the negotiating table.


On the general obligation front, the government presented representatives of the island’s largest debt holders with a proposal for a comprehensive restructuring structure — a “superbond” — that would consolidate the commonwealth’s different credits, Government Development Bank (GDB) President & Chairwoman Melba Acosta is said to have described the meetings with creditors’ advisers as “very positive and productive,” while stressing that no negotiations were conducted at this time, as it was only an “informative meeting.” She acknowledged that the administration is seeking to finish restructuring talks by summertime. Friday’s meetings in New York included representatives of different creditor groups, along with the Sales Tax Financing Corp. (COFINA), GDB and general obligations (GOs). Advisers representing mutual funds and cooperatives holding Puerto Rico debt also took part in the presentations. Commonwealth bond insurers didn’t participate in the meetings, according to Acosta.

She was quoted as saying “If we have different credits that have different repayment sources, and we would have single structure, then there will most probably be a consolidation of repayment sources,” she acknowledged, while adding that more details on the commonwealth’s proposal will be released later. Other reports indicate that as part of that new bond, general obligation holders would have the first claim on government revenues, giving them the highest priority in the superbond structure. Holders of other forms of the government’s debt would have lower priority. It is not clear whether bondholders, in return, would be asked to buy the superbond at a discount, resulting in a haircut on their current holdings.

When asked if a forbearance agreement similar to what was negotiated with PREPA was sought, Acosta said that hadn’t been discussed yet, but could be as the commonwealth moves forward with its debt-restructuring efforts. Friday’s meetings in New York included representatives of different creditor groups, including Sales Tax Financing Corp., GDB and general obligations (GOs). Advisers representing mutual funds and cooperatives holding Puerto Rico debt also took part in the presentations. Commonwealth bond insurers didn’t participate in the meetings, according to Acosta. The hedge funds hope that Washington will avoid taking any measures that might undermine that process.

On Dec. 1, the  Government Development Bank must make a $354 million debt payment. Moody’s has predicted that the government would skip some of those payments because of the worsening liquidity situation. Officials have stayed publicly vague about whether they intend to make the Dec. 1 payment. Ms. Acosta, the president of the Government Development Bank, said the government had yet to make up its mind on whether to make the debt payment next month or another large payment coming due in January.

Those pushing for Gov. Alejandro García Padilla to default to force the creditors, including the hedge funds, to the negotiating table argue that it might also prompt Congress to act faster to give Puerto Rico access to Chapter 9 — something many creditors want to avoid.

We advise investors to take the various published comments and press commentaries with some perspective. The idea of a universal settlement has great appeal to the Commonwealth but whether such an arrangement is appropriate for the many different classes of investors is another thing. The monolines have the capacity to absorb some level of loss but their interests are more akin to those of the individual par buyer. The deep discount hedge fund investors with a shorter time horizon have a much different set of ideas as to what is an acceptable outcome. Full repayment may never have been their actual goal. Many holders of COFINA sales tax debt will be greatly disappointed to be treated as general creditors after the Commonwealth went to such pains to market the bonds as such a distinct credit. Investors in all classes will likely never achieve certainty about the actual validity and value of the Commonwealth’s long standing ‘constitutional pledge” supporting GO debt and its ability to “clawback” taxes pledged to other debt for repayment.  It will probably be an unsatisfactory outcome for many which means it’s likely to be viewed in the long run as a good deal for the Commonwealth.


As we enter the final month of the year, a few trends are emerging reflecting the uncertainty around the economy and timing of an interest rate increase. These are having a direct impact on the market, the profitability of market makers, the appetite for bonds, and the ability to transact high yield credits in the new issue market.  Prominent among these is the decline in trading activity and its implicit impact on liquidity. Municipal bond trading declined in every month through September and even with a slight increase in October remained some 17% below average monthly volume. For the year, monthly trading declined 34% from January to October.

The decline in activity has obviously made it more difficult for the more marginal players and those without robust investment banking capabilities. Retail oriented shops are having a much more difficult time. Concurrently, the reduced number of outlets overall has made it harder for portfolio managers to transact and to make room for new issues. This has reduced the overall appetite for bonds and made it harder for large year-end high yield issue to be absorbed resulting in some cancellations of sales.

What does this all imply for credit? Investors must be much more selective in their choice of higher yielding bonds. It will be harder going forward to manage this risk, especially in the more speculative segments of the credit spectrum. At the same time, the results of the Puerto Rico debt restructuring could still have an impact on spreads as the market values the results and then weighs relative risks of different credit classes accordingly. None of these issues are likely to increase liquidity thus exacerbating the existing inertia in the market. It continues to be a time for caution with rates at absolute lows and spreads remaining tight.


In an unexpected development, a plan to cut property taxes statewide moved near collapse this past weekend, imperiling with it the tentative budget deal struck this month by Gov. Wolf and leaders of the Republican-led legislature. Without the property-tax reduction – a key feature of the $30 billion state spending plan – “the whole agreement fails,” said one high-ranking Democratic official, speaking on the condition of anonymity.

The budget plan presented by Gov. Wolf and GOP leaders in the legislature had called for a rise in the state sales tax from 6 percent to 7.25 percent. The $2 billion it was projected to generate was expected to increase school funding and offset a reduction in property taxes – the primary funding source for local school districts. But neither side has detailed how the education funds will be distributed, the form of property-tax relief or other key concepts in their deal – reform of the state’s pension system and state sales of wine and liquor.

In a letter to his Democratic caucus Saturday, House Minority Leader Frank Dermody (D., Allegheny) said Republican leaders told Wolf late in the week that they could not muster the votes among their members to pass the property-tax plan. “By failing to deliver the votes for the framework they agreed to, the Republican leaders would effectively kill the property-tax relief envisioned as part of the framework,” the letter said. Republicans acknowledged the new hurdle but strove to paint less of a doomsday scenario. “We are going to continue to work on the other segments of the agreement and hopefully bring it to closure,” said Drew Crompton, the Senate’s top Republican lawyer.

Five months into the impasse that has left schools, nonprofits, and other agencies turning to loans and credit to stay afloat, the two parties hailed what they said would be a historic agreement to help fund schools and shift away from the long-term reliance on the property-tax burden. The plan might have lowered property taxes a minimum of 20 percent and a maximum of 40 percent from current rates.

Strains in the agreement became evident  – and may have been worsened – last week, when the Senate unexpectedly let it be known that it intended to vote on a bill that would eliminate property taxes altogether. Its sponsor predicted it would pass. Members of the GOP House caucus were always skeptical of the so-called framework, but said that skepticism turned into opposition for some when it became apparent that the Senate was on the verge of passing a bill to eliminate property taxes altogether. On Monday night, the Senate took up a proposal designed to eliminate school district property taxes by raising the sales and personal income taxes, a plan Mr. Wolf cited as one that he opposed. Members tied 24-24 on a preliminary vote on the proposal, and Lt. Gov. Mike Stack broke the tie by voting no. A similar measure has failed in the House in the past.

New proposals being considered include expanding the list of items that would be subject to the sales tax. As it stands now, there are dozens of exemptions to the sales tax. Whether the Governor would agree is questionable – he campaigned last year on a pledge to provide significant property-tax relief. A new tax on natural gas drilling remains off limits in the negotiations.
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