What Are the Consequences of Default?

August 4, 2015

Default & Its Consequences. The Puerto Rico Public Finance Corp. (PRPFC) yesterday defaulted on 99% of its due payment of some $58 million, according to Government Development Bank for Puerto Rico president Melba Acosta Febo, with Mr. Acosta stating that the decision by the Puerto Rican government not to appropriate funds to pay the debt “reflects the serious concerns about the commonwealth’s liquidity in combination with the balance of obligations to our creditors and the equally important obligations to the people of Puerto Rico to ensure the essential services they deserve are maintained.” Puerto Rican officials have said that the PRPFC default does not constitute a Puerto Rican government default; nevertheless, the default marked the first default by the U.S. commonwealth and could open a Pandora’s Box as the U.S. territory now enters unknown territory in seeking to restructure about $72 billion in debt without access to a federal bankruptcy court. But like the first skittering of stones marking an avalanche, yesterday’s default appears likely to be the first in a broad series of defaults in coming days and months. The bank did pay about $628,000 remaining from prior funds.

The event came as the cost of debt for the island continued to escalate: Puerto Rico municipal bonds were trading at levels more than 30% below their issuance levels of just a year ago yesterday in the wake of the default. Because the defaulted bonds were so-called “appropriation bonds,” as opposed to full faith and credit general obligation or revenue bonds—that is, bonds backed by the legislature’s willingness to appropriate funds to pay the interest rate payments due to holders—the bonds (and bondholders) have far fewer protections than most municipal bonds issued by states and local governments. Indeed, the official statement for the 2011 series A PRPFC bonds states on its first page: “The 2011 series A bonds will not constitute an obligation of the commonwealth or any of its public instrumentalities (other than the corporation), and neither the commonwealth nor any of its political subdivisions or public instrumentalities (other than the corporation) will be liable thereon.” Nevertheless, Puerto Rico yesterday afternoon announced that it had “temporarily suspended” setting aside funds on a monthly basis for general obligation debt service payments, notwithstanding assurances by government officials that the commonwealth will nevertheless make the GO bond payments. Puerto Rico has said its debt includes about $18.6 billion of general-obligation bonds and government-guaranteed debt, $15.2 billion of sales-tax-backed bonds and $24.1 billion of bonds issued by government agencies, like the Puerto Rico Electric Power Authority, which is already negotiating a restructuring with creditors. Many investors in every state across the U.S. hold Puerto Rico’s municipal bonds across the different sectors, meaning they might which could recover different amounts in a restructuring. Fabulous Matt Fabian, a partner at Municipal Market Analytics, remarked that while worries about Puerto Rico have had little impact on the broader market for state and local capital debt, the deliberately skipped payment could spur new selling by investors of other Puerto Rico commonwealth debt. Moody’s Investors Service vice president Emily Raimes said, “Payment of debt service on these bonds is subject to appropriation, and the lack of appropriation means there is not a legal requirement to pay the debt, nor any legal recourse for bondholders. This event is consistent with our belief that Puerto Rico does not have the resources to make all of its forthcoming debt payments. This is a first in what we believe will be broad defaults on commonwealth debt.”

What’s Next? The default entered Puerto Rico in a place beyond San Bernardino, or Detroit, or Jefferson County, because the U.S. territory has no legal access to ensure protection for essential public services, much less a federal judge to preside over negotiations with the islands thousands and thousands of creditors. A group of Puerto Rico policy makers is working on a restructuring plan—such as a plan of adjustment negotiated by a city in municipal bankruptcy—but without those protections. The policy makers hope to present their findings at the end of August. Creditors, including mutual funds, hedge funds and other distressed-debt investors, have been splitting into committees based on which kinds of Puerto Rican municipal bonds they own—but it promises to be an unprecedented restructuring process unlike any that has ever occurred in U.S. history.

Caught between Governance, Democracy, and Municipal Bankruptcy

August 3, 2015

Aching for a Fiscally Sustainable Tomorrow. Saturday marked the third anniversary of San Bernardino’s municipal bankruptcy filing—making it not only the longest period of any city in such a transition, but also a time of considerable public disruption. Because, in California, unlike Michigan or in a number of other states which authorize municipal bankruptcy, municipal elected officials remain in charge; only in the case of San Bernardino, even there—unlike Jefferson County—there has been significant change—a new Mayor, City Council, and City Attorney. Now even more could well be on the way. Candidates for the Third, Fifth, Sixth, and Seventh Ward Council Member positions, as well as for City Attorney, City Treasurer, and City Clerk, must file for election or re-election next November by the end of this week. For the bankrupt city’s voters and taxpayers, moreover, there is a tenuous balance between local control and the federal court. Almost as if in a twilight zone in a most disinterested state, San Bernardino is suspended not just in a time warp, but also in uncertainty as to critical decisions which will emerge not from their own elected leaders, but also U.S. Bankruptcy Judge Meredith Jury. That is, the city’s elected officials (and prospective challengers) bear not only their responsibility to their constituents and taxpayers, but also to be responsive to the federal court. Unsurprisingly, what might satisfy the federal bankruptcy court is less than likely to meet with citizens’/taxpayers’ hopes. Mayor Carey Davis provided his perspective: “I think there’s a fair amount of frustration on the part of residents with the protracted nature of this, but (bankruptcy) is a long and expensive process to move through…A lot of residents, I find, are surprised, because they saw filing the Plan of Adjustment as a completion. It required a considerable amount of effort to put together that Plan of Adjustment, and so the implementation of that, I think, is going to take just as much work — and I think it will be the most difficult time of the bankruptcy.” One of the terrible ironies of municipal bankruptcy is that a municipality that cannot meet its fiscal obligations is, after all, beset with very significant costs in bankruptcy: as of last February, San Bernardino had already more than doubled its budgeted costs for the municipal bankruptcy process from $4.1 to $9.3 million.

Pop Goes the Weasel. Sort of like the musical chairs game we played as kids, where when the music stopped—and one chair had been removed—someone was out. What is different is that in the case of Puerto Rico, with default now happening, and Puerto Rico’s government having suspended setting aside funds to meet its general obligation debt, the issue is rather which creditors will not be paid—especially in the wake of the Puerto Rico’s Treasury announcing that the government was not making the set asides—or, as Puerto Rico Secretary of the Treasury Juan Zaragoza put it in an interview: “We aren’t making the monthly deposits. But that does not mean in any way that we won’t pay our GO obligations.” Of course, it does not mean Puerto Rico will. As of today, the U.S. territory has moved into a fiscal Twilight Zone. Under legislation Governor Alejandro García Padilla signed, Puerto Rico is authorized to suspend set asides as long as it finds itself unable to borrow some $1.2 billion in intra-year funding or the Puerto Rico Infrastructure and Finance Authority cannot sell a $2.9 billion gas-tax supported bond. So, now the island—and its creditors—find themselves in a brave new fiscal world where—outside of municipal bankruptcy—there are few prescribed rules; moreover, unable to access federal bankruptcy, there is no federal bankruptcy judge to either ensure the protection of essential public services, much less to act as a referee amongst the clamoring creditors. Puerto Rico’s constitution prioritizes the payment of its guaranteed debt over any other financial need. The approved fiscal year 2015-2016 General Fund budget allocated $1.011 billion for general obligation debt, and a Treasury spokeswoman on Friday confirmed that the Government Development Bank had transferred about $170 million to the bond trustee for payments of its debts today.

How Does One Define “Essential Public Services” for a Municipality in Distress?

July 31, 2015

Securing a Safe & Sustainable Fiscal Future. Michigan Gov. Rick Snyder yesterday affirmed his declaration that Wayne County is in a financial emergency—an affirmation almost certain to trigger a partial state takeover of the county—a county which encompasses not just Detroit, but also 33 other cities and 9 townships. In his statement yesterday, Gov. Snyder said: “Officials have taken steps to begin addressing the county’s crisis, but there can be no disputing that a financial emergency exists and must be addressed swiftly and surely to ensure residents continue to receive the services they need and deserve and the county can continue its economic recovery.” The decision immediately started a stopwatch which will give the Wayne County Board until next Thursday to choose among four options offered under Michigan law to municipalities in financial emergencies:

• municipal bankruptcy;
• a consent agreement with the state;
• authority to request a neutral evaluator; or
• an emergency manager.

Wayne County Executive Warren Evans has said he has been hoping for a consent agreement to fix the county’s finances: such an agreement would spell out specific budgetary steps and reforms the county would have to undertake and complete to address the county’s $52 million structural deficit. Wayne County has been caught between a rock (significant declines in property tax revenues, estimated to be as much as $100 million annually since 2008) and a hard place: its underfunded public pension system. The county is confronted with an accumulated deficit of $150 million. Should the county opt for entering into a consent agreement, such an option would give Wayne Count broader authority to impose reforms on expired labor contracts and would leave the bulk of the restructuring under local, rather than state control. But, as some of the county’s commissioners warn, a consent agreement could instead lead to a preemption of local authority and a state takeover—as happened to Wayne County’s largest city: Detroit. Perhaps Wayne County Commission Chairman Gary Woronchak described it best: “We have a difficult decision ahead of us, because we have to choose from one of these four options…They may seem simple on their face, but there are little trap doors along the way that we should well be aware of while we’re making this decision.”

Stopping the Fiscal Bleeding & Financing Essential Public Services. Wayne County’s Treasurer is getting ready this fall to auction off as many as 30,000 properties: a record number of tax delinquent properties, nearly half of which were eligible for foreclosure years ago. About $193 million is owed in taxes and fees on the 30,000 Wayne County foreclosures, including $95 million in debt on properties that had more than five years in unpaid bills. Of that record number, nearly half are delinquent on their property taxes for five or more years: Michigan law provides for foreclosure after three years of nonpayment. As in Detroit’s experience, failure to foreclose creates a double whammy: first, an ever-growing erosion of assessed property values and collected property taxes in neighborhoods, and an ever-increasing cost and burden to the county to foreclose: this year, the Treasurer’s office is trying to foreclose on Wayne County’s vast majority of tax delinquent properties. To get some idea of the scope, over the last seven years, Wayne County has taken 108,500 properties to auction. A key issue, of course, is tax delinquencies: when the patient is bleeding, it is critical to stanch the flow, because, as Wayne County Chief Deputy Treasurer David Szymanski wrote in an email to The Detroit News: “Payment of these delinquent taxes is essential to support essential government services.” Wayne County is scheduling a first round of tax auctions in September, which is when foreclosed properties will be sold for the full debt owed—with whatever is not sold re-offered the following month.

Shared or Different Fiscal Destinies? Robert Frost, in his wonderful poem “Mending Walls,” wrote “good fences make good neighbors,” and so it is that Detroit and Wayne County are more than neighbors—as Detroit is in Wayne County. But even as Wayne County is in a financial emergency, Moody’s yesterday upgraded the City of Detroit one notch to B2 from B3, with a positive outlook, reporting that its upgrade reflects Detroit’s improved financial position following its exit from municipal bankruptcy. Moody’s added that the upgrade incorporates management’s continued improvement of city financial operations and signs of economic development in the city—even as it pointed out the city’s ongoing population loss, persistent tax base weakness, and taxable valuation declines—declines which it projects will continue over the near-term.

How Does on Define “Essential Public Services”? Perhaps the single most critical value of municipal bankruptcy is the immediate protection of a city or county’s ability to ensure the provision of essential public services while its sorts out its debts under the ever watchful scrutiny of a federal bankruptcy judge—certainly a part of the great apprehension in Puerto Rico is that, absent such a judicial protection, those in most dire need and who have the least legal or fiscal resources will be ill-equipped to compete with the hedge funds. But that raises a hard question: just what are essential public services? In San Bernardino, that question is front and center as the city, with an 18.9% unemployment rate, has determined, by a 4-2 Council vote, to appropriate $250,000 to keep a job center open for at least another two months as it appeals the state’s decision to reject the Mayor and Council’s request for funding—that is, $250,000 that the bankrupt city does not have. Nevertheless, the vote affirms the city’s decision to keep the doors of opportunity open for some 138 individuals currently enrolled in training programs or on-the-job-programs, to close out grants, and to otherwise wind down the agency. One can appreciate how hard it would be to draw the fine line between what is essential and what is not. San Bernardino Councilmember Rikke Van Johnson, in the majority of those voting to keep the city’s 40-year-old program on temporary life support said: “It’s integral, if we’re going to move out of this bankruptcy, that we keep our assets that will aid us in getting out of bankruptcy…and that’s what the San Bernardino Employment and Training Agency will do.” While the city’s workforce development attorney, in a seven-page opinion for the Council, wrote that she believes the city will be reimbursed most or all of the money, there was little certainty whether that would, in fact, happen as well as the growing expense—even as the city faces ever-growing bills over the next twelve to eighteen months from the prohibitive costs of municipal bankruptcy. Already San Bernardino has had to cut public safety, outsource jobs, and agree to a settlement under which its retirees will lose some $40 million in health benefits. Councilmembers Fred Shorett and Jim Mulvihill, who voted against the funding, wondered whether and how the decision might affect the city’s case in the U.S. bankruptcy court before Judge Meredith Jury—including with regard to the city’s fiscal discipline, noting: “We’re in bankruptcy because previous councils refused to say no.”

As we have written before, the exceptional complications of democracy and municipal bankruptcy—as provided under certain state authorizations of municipal bankruptcy, such as Alabama and California—create singular civic challenges—challenges that are about governing—and in sharp contrast to municipal bankruptcies in states such as Michigan and Rhode Island, where the Governor appoints an emergency manager or receiver and the mayor and council are barred from any role or governance responsibility—as are the voters and taxpayers. So it was perhaps unsurprising this week to note that the San Bernardino community came out in force for the meeting to determine the fate of the agency, an agency which, over the last four years has served about 48,000 people through job training, placement, and other services.

Cadena de Eventos. With the Congress off in the hinterlands and having spurned any action to provide Puerto Rico or its municipalities any access to municipal bankruptcy, the U.S. territory is on the brink of setting in motion a chain of events (cadena de eventos) which will take us into a state and local bankruptcy twilight zone—as tens of thousands of creditors will be caught up in unrefereed negotiations about how to restructure Puerto Rico’s $72 billion debt—with the triggering event the almost certain default of the Puerto Rico Public Finance Corporation, for which the legislature has not appropriated the requisite $58 million necessary for the utility to make payment to its bondholders tomorrow. That the default will happen should hardly come as a surprise: Governor Alejandro Garcia Padilla made clear last month that Puerto Rico cannot repay its obligations and sought a delay in debt payments—even as he hopes to propose a debt-restructuring plan by September 1st. The non-payment at issue, defined as a moral obligation bond—as opposed to full faith and credit—because it is dependent on a legislative appropriation—is more like the first granules in an avalanche that offer the briefest of warnings of what could follow. Nevertheless, with the Public Finance Corp. having (technically) until the end of business on Monday to make the payment, Puerto Rico tomorrow will enter into an uncharted and unprotected fiscal future—a future lacking the protections of a U.S. bankruptcy court to ensure the provision of essential public services—and a future in which those most at risk—such as Puerto Rico’s retirees and poorest U.S. citizens—will be least equipped to achieve a fair outcome or a sustainable fiscal future. Puerto Rico’s largest pension fund, according to Moody’s, could deplete its assets by 2020: it has 0.7 percent of assets to cover $30.2 billion of projected costs, according to financial documents. The PFC default will not be the only one tomorrow: other Puerto Rican debt payments due tomorrow include $91.5 million of principal and interest on Municipal Finance Agency bonds repaid with payments from San Juan and other towns—in addition to $252 million of principal and interest on debt backed by the island’s sales-tax levy. There are also Government Development Bank bonds due tomorrow (The bank, which lends to the commonwealth and its municipalities, has $140 million of municipal bonds maturing $29 million in interest payments due, according to data compiled by Bloomberg.) Perhaps forgotten in this telescoping of fiscal events is that Puerto Rico and its instrumentalities are not just facing default, but also a perilous slope of capital borrowing costs: costs which have increased by close to one-third.

Public Service Delivery Insolvency

July 30, 2015

Securing a Safe & Sustainable Fiscal Future. With a violent crime rate more than 500% of the U.S. national average, but empty city coffers, San Bernardino’s municipal bankruptcy filing was critical to stanching not just its credit, but also its ability to protect its citizens. A critical purpose of the federal municipal bankruptcy law, after all, is to preserve the ability of a city or county to continue to provide essential public services. Ergo, notwithstanding its bankruptcy, it appears that the City of San Bernardino could be a step nearer a more secure future, with all the ramifications that would have for assessed property values, in the wake of its announcement yesterday that after more than two years’ of watching its police officers leave the force and the city, city negotiators and the police union said they had agreed on a new contract, albeit one subject to ratification by the City Council. The San Bernardino Police Officers Association yesterday reported an overwhelming vote in support of the new pact, with their spokesperson noting: “We also anticipate that the deal…will hopefully keep men and women on the force from exiting the city of San Bernardino.” U.S. Bankruptcy Judge Meredith Jury, at a hearing on the city’s municipal bankruptcy yesterday, praised the two sides for reaching the pact and a mediation judge for helping broker it, noting: “It is an incredibly important step… It is a very big step, and I hope the city votes in favor next week.” Judge Jury added she hoped it would end adversarial court filings by the police union, which has been one of the city’s main creditor challengers in her courtroom, albeit Judge Jury added that she did not expect the adversarial nature of the fire union to change at all: “Obviously that’s not going to happen….” After the hearing, Mayor Carey Davis said the deal was “very favorable” to the city, while City Attorney Gary Saenz said it was a milestone in efforts to turn around the city: “This is a very good deal for the city and a very good deal for the police, but most of all, it’s a very good deal for the citizens of San Bernardino…The Police Department and the city are once more on the same side, and police will have the stability to improve the crime rate that many people, in the survey we did as part of the strategic planning process, identified as one of the main issues in the city.” The agreement, if ratified by the Council, would replace the current terms imposed by the city two years ago in January—terms which police officers believe have contributed to the high rate of turnover. Nevertheless, the agreement, even though praised by Judge Jury in her courtroom, will not go unchallenged: even though it means the city’s plan of debt adjustment before the federal bankruptcy court will—if the agreement is ratified by Council—be modified to incorporate the agreement; it is a change that would likely come at further expense to the bankrupt city’s municipal bondholders—creditors already slated under the city’s plan to only receive one penny on each dollar they are owed. Bondholders’ attorney Vincent Mariott yesterday testified before Judge Jury he was concerned by the slow pace with which he claimed San Bernardino has provided documents, especially with regard to those which purport to defend the city’s plan proposal to, in a manner similar to Stockton, make disproportionately deep cuts to creditor bondholders—or, as attorney Mariott put it: “We’re of course entitled to a full understanding of why the city believes that wiping us out is necessary…We do need the city to be more responsive than it has been to date.”

Resecuring Fiscal Sustainability. Motown is fixing for its amazing comeback, planning to issue its first sale of municipal debt on August 19th—with an estimated issuance of $245 million in municipal bonds, with the proceeds of the sale dedicated to repayment to Barclays for the $275 million loan which marked the final key step which secured Detroit’s exit from the largest municipal bankruptcy in U.S. history. Mayor Mike Duggan yesterday said the new bonds are essential to improving Detroit city services—and have earned an upgrade to A from Standard & Poor’s, adding: “If you had said six months ago there was any chance the city of Detroit could be borrowing with an investment-grade credit rating, people would have thought that was very unlikely…But it gives you an indication of how far we’ve come in a short period of time.” S&P awarded the grade, with a stable outlook, to the Michigan Finance Authority’s Local Government Loan Program revenue bonds, e.g., bonds issued on behalf of Detroit and based on a first-lien pledge of the city’s income tax. In addition, the bonds are secured by a limited-tax general obligation pledge. The upgrade, according to the city, could mean savings of as much as $2.5 million annually and $20 million in interest costs over the life of the Motor City debt. The financial recovery bonds were originally privately placed with Barclay’s Capital Inc., in December as the city made its exit from Chapter 9. The savings highlight the exceptional role the State of Michigan has taken—in stark contrast to the states of California and Alabama, for instance—especially in view of Detroit’s own S&P B rating— five grades below the lowest invest-grade rating. The improvement also reflects the remarkable revenue turnaround: Detroit’s tax revenue has been rising for the past four years, The improved rating also reflects an intriguing wrinkle: the bonds are secured by Detroit’s municipal income tax—tax revenues in this instance which will bypass the city treasury and go directly to a trustee so that the tax proceeds must first be dedicated only to pay bondholders, even going so far as to provide, under the terms of the bond documents, for daily deposits as tax revenue is collected—or, as S&P’s credit analyst Jane Ridley describes it: “The ‘A’ rating isn’t based on the credit of the city itself…It’s based on the strength of the revenue pledge and the income stream. It doesn’t really stay in the city’s hands at all. It’s designed to be immediately taken by the trustee for the benefit of bondholders.” Gov. Rick Snyder, in April, signed into law legislation giving bondholders a statutory lien on the city’s income-tax revenue as way to ease Detroit’s first post-Chapter 9 return to the capital markets. The law also gives the bonds an intercept feature, sending income tax revenue first to a bond trustee who will extract enough to cover debt service and send the rest to the city. Put another way by the ever insightful Lisa Washburn, a managing director for Municipal Market Analytics, Detroit’s overall creditworthiness is unlikely to change until it posts 1) several years of growth and stability in tax revenues, 2) increasing investment in the city, and 3) a stable city government which can improve city services, adding: that will be a multi-year process.” The proceeds of the municipal bonds here will be dedicated to financing key priorities, including the overhaul of its financial management system and the Detroit Fire and Police department fleets.

Referring to the sale at an MSRB seminar Tuesday, Kevyn Orr, Detroit’s former emergency manager who guided the city into and out of municipal bankruptcy, kidded the Board: “I hope you buy early and I hope you buy often.” Under the original agreement, Barclays was to hold the taxable debt for up to 150 days in a variable-rate mode, and the city was to refund the bonds publicly in a fixed-rate mode. The loan was extended by 90 days in May. Of the $275 million, $38 million of the taxable proceeds paid off the banks that acted as counterparties on the city’s interest-rate swaps. Another chunk of proceeds financed new information technology as well as other capital and operating upgrades. The city floated $1.2 billion of bonds in December to pay off creditors, but none of the debt was floated on the public markets. It was directly placed with creditors and participants, though they are securities that can be traded on the markets.

Remembering Motown & Public Service Delivery Insolvency. Reminiscing yesterday about his service in Detroit and its truly remarkable turnaround, Mr. Orr—at the MSRB—said that as the city plummeted into municipal bankruptcy,
• 9-1-1 response time to the highest priority police and emergency medical calls averaged 45 minutes to an hour;
• tax collection was at 65%; 75% of parks were closed; and
• 72 water main breaks occurred in one day last August.
Or (not a pun), as he noted, the noted rhythm guitar playing and now retired (but volunteering his musical and peerless services in Puerto Rico) U.S. Bankruptcy Judge Stephen Rhodes called the U.S.’s largest municipal bankruptcy a “service-delivery insolvency.” But, as he reported yesterday: “Detroit’s a much better credit than it was two years ago,” and he has few qualms about its fiscal future and sustainability: “We built enough of a surplus…They should be fine.”

Too Little, Demasiado Tarde? U.S. Treasury Secretary Jacob Lew Tuesday warned that a failure by Congress to help Puerto Rico resolve its debts may hit the retirement portfolios of average Americans. Secretary Lew’s statements came as Congress was fleeing Washington for its long summer vacation—a departure just days before Saturday’s potential default. Sec. Lew endorsed federal legislation to grant the commonwealth the same access to an orderly municipal bankruptcy regime as every state, noting it was critical to prevent a chaotic and protracted resolution of Puerto Rico’s fiscal challenges—warning that a default would be costly, not just for Puerto Rico, but also the U.S. In an epistle to Senate Finance Committee Chairman Hatch (R-Utah) (and not to Chairman Charles Grassley (R-Iowa), Chairman of the Senate committee of jurisdiction, the Senate Judiciary Committee), he wrote: “The continued deterioration of Puerto Rico’s economic and financial conditions has the potential to further harm retiree investment portfolios across the country…A significant portion of Puerto Rico’s debt is still held directly by individual retail investors or indirectly through the municipal bond funds they own.” On Saturday, long after Congress will have left Washington, D.C. until after Labor Day, $36.3 million of bonds sold by Puerto Rico’s Public Finance Corp. become due. Puerto Rico’s legislature has not appropriated the requisite funds to settle that payment. Because Puerto Rico has not transferred cash to its Public Finance Corporation (PFC) trustee ahead of Saturday’s August 1 debt service payment, the likelihood increases there will be a technical default, or, in Spanish, an incumplimiento technico, a step ahead of what could become the U.S. territory’s first payment default on Tuesday if sufficient funds have not been advanced by the end of this week—a default, which as our ever astute market observers at MMA have already observed: “[E]nhances the political viability of additional defaults everywhere else.”

How Can a Government Provide Essential Services and Create a Plan of Debt Adjustment outside the Protection of a federal Bankruptcy Court?

July 28, 2015

Taking on Fiscal Sustainability. The Detroit News’ insightful columnist Daniel Howes yesterday wrote that Detroit Mayor Mike Duggan’s “readiness to challenge professional fees associated with Detroit’s historic bankruptcy is paying dividends,” noting that those astute challenges had already resulted in some $30 million in reduced borrowing needs, or, as Mayor Duggan’s deputy chief of staff reported: “It’s hugely helpful: For those years the debt service is reduced in principal and interest, you have that much more you can provide in services.” Mr. Howes added: “That’s not all. As part of its expected refinancing in the municipal bond market (the same market that experts predicted would spurn Detroit’s post-Chapter 9 borrowing efforts), the city also plans to restructure repayment schedules to eliminate what would have been larger payments in future years.” That is to note that the kind of fiscal discipline emerging in post-bankrupt Detroit is providing for not just more disciplined financial certainty and disciplined budgets, but also more fiscal resources to support delivery of basic public services—or, as Mr. Howes wrote: “an improved financial profile that could be reflected in credit ratings upgrades, perhaps as early as this week,” adding: “That’s in Detroit, little more than six months after completing the largest municipal bankruptcy in American history. That’s in record time and in a largely consensual proceeding that, for the first time in a very long time, also produced collective bargaining agreements with all the city’s unions.”

Wayne’s World. Wayne County commissioners are expected, today, to discuss options for resolving the county’s financial emergency when they meet as a committee of the whole this afternoon, less than a week less than a week after Gov. Rick Snyder said he agreed with an independent financial review team’s assessment that a financial emergency exists in Wayne County—giving the County until tomorrow afternoon to request a hearing before the state treasurer on the financial emergency declaration. Should they opt, this afternoon, to request such a hearing, the hearing will take place in Lansing on Thursday morning—after which Gov. Rick Snyder can either confirm or revoke his determination that the county is in a financial emergency. Wayne County commissioners eventually could vote for one of four options for state intervention: a consent agreement (which would impose benchmarks the county would have to accomplish); mediation; state appointment of an emergency manager, or filing for Chapter 9 municipal bankruptcy. Wayne County Executive Warren Evans has said he hopes the Commissioners will opt for a consent agreement to fix the county’s finances. The county, which encompasses Detroit and 27 other municipalities, is facing a $52 million structural deficit, caught in a vise between its underfunded pension system and a $100 million yearly drop in property tax revenue since 2008. The county’s accumulated deficit is $150 million.

Incumplimiento Técnico. When Puerto Rico failed, last week, to transfer to transfer cash to a Public Finance Corporation (PFC) trustee ahead of an August 1 debt service payment, that trigger a technical default, or, in Spanish, an incumplimiento technico, a step ahead of what could become the U.S. territory’s first payment default if sufficient funds have not been advanced by the end of this week. Our astute market observers at MMA have already noted to their institutional investor clients: “we expect that even a single default anywhere in Puerto Rico’s capital structure enhances the political viability of additional defaults everywhere else.” MMA notes that “Puerto Rico issuers now account for 59% of all impaired municipal par across all sectors, states, and categories. This creates a challenge in showing that the municipal industry as a whole has very low default and impairment rates. A summarization of all current, non-Puerto Rico impairment across the industry by sector, rating category, etc., shows that the rest of the municipal industry still has very low default rates.” The island’s public utility, PREPA, is seeking to push debt maturities on its $8.1 billion of municipal bonds back by five years, during which time no principal would be paid and interest would be cut to 1%, unless the authority’s cash position warrants it—a different approach—MMA notes, than the more common approach of simply cutting principal and interest payments. That stance by the utility is comparable to what Puerto Rico Governor Alejandro Garcia Padilla is advocating as part of what is shaping up to be the biggest municipal debt restructuring in U.S. history: “The ultimate goal is a negotiated moratorium with bondholders to postpone debt payments a number of years,” albeit, under the utility’s proposed plan, insured debt would be excluded from these treatments. As the potential for default escalates, and the chances of Congress providing access to a U.S. Bankruptcy court evaporate by week’s end with Congress departing for its five week vacation; the pressure is increasing on Puerto Rico’s Working Group for Economic Recovery to cobble together proposals for restructuring the commonwealth government’s debt by September 1st—a process sure to be unprecedented and rocky—already a report released by a group of hedge funds which own $5.2 billion of Puerto Rico municipal bonds wrote that Puerto Rico’s central government can pay what it owes—a thunderous shot over the bow as the island’s leaders seek, with ever diminishing time, to restructure its $72 billion of debt. According to the hedge fund commissioned report, budget cuts and tax increases would allow Puerto Rico to stabilize its finances. The hedge funds are, unsurprisingly, among the first bondholders to challenge Puerto Rico’s claim in June  that it needs to defer debt payments—at least until Gov. Padilla’s administration completes its draft proposal by the end of August for restructuring the island’s debt, an unprecedented effort in the U.S. which is certain to be challenged in court. The public challenge for Puerto Rico, in effect, is how to put together a plan of debt adjustment without the protection of bankruptcy to ensure uninterrupted ability to maintain essential public services. Remembering that Detroit’s process of putting together and obtaining Judge Steven Rhodes’ approval of its plan of debt adjustment consumed 18 months, one can appreciate not just the fiscal, but also the moral dilemma—or, as the Gov.’s chief of staff, Victor Suarez, puts it: “[T]he simple fact remains that extreme austerity placed on Puerto Ricans with less than a comprehensive effort from all stakeholders is not a viable solution for an economy already on its knees.” That is, there is no longer any question that Puerto Rico’s creditors will not be held harmless—Moody’s has already speculated that some investors may receive as little as 35 cents on the dollar on some securities, while owners of debt with the greatest safeguards could receive more than twice as much. Indeed, Moody’s, in its report, noted that it is a near certainty that Puerto Rico will default on some of its securities, possibly as early as this Saturday, when $36.3 million of bonds sold by its Public Finance Corp. become due—the legislature simply has not appropriated the funds. Thus will begin the great gladiator battles: different legal protections for Puerto Rico’s securities promise to pit owners of Puerto Rico general-obligation bonds, which have a constitutional pledge of repayment, against holders of other bondholders, such as sales-tax debt, which are backed by dedicated revenue sources. The hedge-fund group holds both types of securities.

Our perceptive friends at MMA note that were Puerto Rico able to avert a default, that would leave the proverbial door or “puerta” open to the idea of voluntary concessions by bondholders to remain viable for at least a bit longer; avert a new round of costly and goodwill‐consuming litigation from creditors; and, most importantly, reduce the risk of other island stakeholders organizing to protect their interests. The key point MMA makes is that: “we continue to strongly believe that a Puerto Rican default on any government‐related security would greatly increase the risk of additional defaults elsewhere. However, should Puerto Rico actually default on a debt payment, the implication would be that the U.S. territory has either chosen not to pay (perhaps referencing the government’s police power—the ultimate trump card vis‐à‐vis bondholders—as did the director of Puerto Rico’s OMB last week) or cannot pay while cash and liquidity are so scarce. Both scenarios are deeply unfavorable to [municipal] bondholders and could signal the start of a new, more adversarial chapter in creditor negotiations.” The ever perceptive MMA adds that the fiscal road ahead will, if anything, become more precipitous, as there is a projected sharp decline in expected FY15 commonwealth revenues, the government’s holdback of nearly 50% of 2015 income tax refunds, and what the Washington Post quotes a Pew director describing as, “the biggest movement of people out of Puerto Rico since the great migration of the 1950s.”

Post Bankruptcy Fiscal Discipline

July 24, 2015

Taking on Fiscal Sustainability. The Detroit News’ insightful columnist Daniel Howes yesterday wrote that Detroit Mayor Mike Duggan’s “readiness to challenge professional fees associated with Detroit’s historic bankruptcy is paying dividends,” noting that those astute challenges had already resulted in some $30 million in reduced borrowing needs, or, as Mayor Duggan’s deputy chief of staff reported: “It’s hugely helpful: For those years the debt service is reduced in principal and interest, you have that much more you can provide in services.” Mr. Howes added: “That’s not all. As part of its expected refinancing in the municipal bond market (the same market that experts predicted would spurn Detroit’s post-Chapter 9 borrowing efforts), the city also plans to restructure repayment schedules to eliminate what would have been larger payments in future years.” That is to note that the kind of fiscal discipline emerging in post-bankrupt Detroit is providing for not just more disciplined financial certainty and disciplined budgets, but also more fiscal resources to support delivery of basic public services—or, as Mr. Howes wrote: “an improved financial profile that could be reflected in credit ratings upgrades, perhaps as early as this week,” adding: “That’s in Detroit, little more than six months after completing the largest municipal bankruptcy in American history. That’s in record time and in a largely consensual proceeding that, for the first time in a very long time, also produced collective bargaining agreements with all the city’s unions.”

July 23, 2015

Financial Emergency. Michigan Gov. Rick Snyder yesterday affirmed the conclusion of the state’s five-member independent review team and declared a financial emergency in Wayne County, stating: “Local leaders have taken important steps toward resolving the financial crisis that has challenged the county for several years, but the review team’s report clearly shows that a financial emergency exists…Chronic financial crises will only grow worse, and the possible solutions will be far more difficult, if the crisis is not addressed immediately. Restoring Wayne County to a secure financial foundation will ensure residents will continue to get the services they need.” In a statement issued after Gov. Snyder’s declaration, Wayne County Executive Warren Evans said the Governor’s decision confirms the county’s own findings of an emergency: “We maintain the position that a consent agreement is the best option going forward…We will seek a consent agreement that respects the roles of the Wayne County executive and commission, and gives us the tools to focus our efforts on resolving the $52 million structural deficit.” County commissioners eventually can vote for one of four options for state intervention: a consent agreement, which sets benchmarks the county would have to accomplish; mediation; an emergency manager; or Chapter 9 bankruptcy. Wayne County is struggling with a $52 million structural deficit. The recurring shortfall in Michigan’s most populous county, which encompasses Detroit, stems from the underfunded pension system and a $100 million yearly drop in property tax revenue since 2008. Its accumulated deficit is $150 million. County leaders have until 5 p.m. July 29th to request a hearing on the Governor’s determination.

Impago is the word in Spanish for default, which Moody’s late yesterday opined the probability of to be approaching 100% for the U.S. territory of Puerto Rico, adding that the losses given default will be substantial: “We assume the commonwealth will seek to restructure its debt in a consolidate fashion, affecting all [municipal] bondholders to varying degrees.” The rating agency added the federal government is unlikely to bail out Puerto Rico—and that bankruptcy would not be a viable solution, adding that “any effort by the federal government on the commonwealth’s behalf would have marginal near-term effects.” In its report, Moody’s noted: “The federal government does not provide states or local governments with extraordinary funds to avert defaults on their debt, in part because doing so would induce other governments to take on unsustainable amounts of debt or engage in reckless fiscal practices.” The agency did not note that the federal government, in contrast, does provide extraordinary funds to other kinds of corporations on Wall Street and in Detroit—just not municipalities, U.S. territories, or states. In the Q&A from Moody’s VP and Senior Credit Officer Ted Hampton, Moody’s also downplayed the efficacy of chapter 9 municipal bankruptcy to help: “Since Chapter 9 is unlikely to be a viable way to achieve a consolidated restructuring of all the commonwealth’s debt, bankruptcy authorization would not be sufficient by itself to manage Puerto Rico’s current pressures…A bankruptcy filing might provide for a more orderly process with comparatively better recovery rates for a subset of bondholders, excluding direct debt of the central government as well as public corporations unable to show insolvency.” The very high likelihood that Puerto Rico will default and significantly restructure its obligations affecting all of its bondholders to varying degrees, provokes questions about expectations for bondholder recoveries, so that Moody’s added: “We believe bondholder recoveries will be lowest on securities lacking explicit contractual or other legal protections. These securities consist of those rated Ca, including notes issued by the Government Development Bank for Puerto Rico (GDB, Ca negative) and the commonwealth’s subject-to-appropriation debt.” Moody’s noted that Congress, should it not opt—as appears more likely than not—to authorize the U.S. territory access to municipal bankruptcy, could take action to support Puerto Rico besides giving it the ability to use the U.S. Bankruptcy Code, such as through the appointment of a federal financial control board or amendments to the Jones Act, which mandates Puerto Rico use expensive U.S. ships for shipping activities. The rating agency, in its grim outlook, noted that Puerto Rico’s fiscal situation will continue to deteriorate, because the island “lacks an obvious engine of recovery” and faces a continually contracting economy with longstanding immigration away from the island leading to a labor force participation rate of 40% compared to the continental U.S. overall participation rate of 63%.

Waiting for Godot. Meanwhile the U.S. Treasury Department has remained firm that it will not pursue a bailout; it will defer to Congress with regard to any federal response to Congress. Both the House and Senate have bills pending that would allow Puerto Rico’s municipalities and public corporations to seek bankruptcy protection under Chapter 9, an avenue afforded in states, but there has been no progress to date—and with Congress scheduled to go on vacation at the end of next week and not return until September 8th, likely past when Puerto Rico will have a default, the chances of Congressional action appears more and more unlikely. The bill in the House was introduced in February and has been sitting in a subcommittee of the House Judiciary Committee since March. The bill in the Senate, introduced last week, was referred to the Senate Judiciary Committee where it appears to have gained no traction.

Surf’s Up. Meanwhile, Moody’s is decidedly less moody about Atlantic City, which reports it has sufficient cash to meet its August general obligation debt service payments and expects to have sufficient liquidity through October: Revenue & Finance Department Director Michael Stinson reports that Atlantic City has roughly $30 million in cash, which will enable it to cover debt service payments of $3.5 million due this Saturday, and $2.5 million on August 15th–a $12.3 million short-term maturity due next Tuesday will be covered by proceeds from a May sale of state-enhanced bonds. In fact, Director Stinson said Atlantic City has enough cash to meet its needs until Nov. 1st if third-quarter property taxes are collected on schedule—a schedule he fully expects the city to meet—or, as he puts it: “We are moving in a positive direction.” Indeed, Moody’s on Monday issued a report writing that Atlantic City’s ability to meet August payments is a credit positive since it has been able to raise sufficient cash for debt service while continuing to seek long-term solutions for confronting financial challenges. The credit rating agency had downgraded Atlantic City six notches to Caa1 last January in the wake of Gov. Chris Christie’s decision to place the city under emergency manager control. Josellyn Yousef, Moody’s analyst, noted the factors which will determine the future of Atlantic City’s financial stability include whether Gov.—and now Presidential candidate–Christie signs legislation adopting a rescue package for the city (The rescue package awaiting Gov. Christie’s signature would create a payment in lieu of taxes program for casinos which would eliminate the risk of future tax appeals.), a timely adoption of a balanced 2015 budget and manageable settlements on casino tax appeal refunds. The rating agency added that the shuttered Revel casino, delinquent on some $32 million of 2014 property taxes, is current on its bills owed to the city so far in 2015, adding stability to Atlantic City’s 2015 cash flow. Ms. Yousef noted that the future of tax-appeal refunds to casinos will play an especially important role in Atlantic City’s turnaround efforts, adding that a solution must be found soon, adding: “A lengthy, expensive litigation battle with casinos would significantly strain city finances, conceivably driving the city into bankruptcy: The city needs the casinos’ cooperation to work out a solution for the nearly $200 million of tax appeal refunds it owes them, $153 million of which must be paid to the Borgata casino alone. The liability to casinos approaches the city’s $270 million of GO debt.” The Garden State city is facing a $101 million budget gap; it was hit hard by four casino closures last year—closures which costs hundreds and hundreds of jobs and a significant hit to property tax receipts and assessed property values. Ms. Yousef said the city must mail fourth-quarter tax bills by the end of September to allow sufficient time for an accelerated tax lien sale before the end of 2015, which allow the city to collect unpaid property taxes, warning that a delay past October would likely postpone property tax collections and “strain liquidity” when an $11 million debt service is due in December.

“A Greek Tragedy in Houston.” Don Hooper, who is an oil and gas executive based in Houston, writing for Big Jolly Politics, this week wrote that “the reality of the City of Houston’s financial condition will continue to be glossed over by city leaders. Only recently did the city’s finance director announce that the city is out of magic tricks. They have sold every city asset with any value and these one-time cash infusions used to balance the city budget are over. It took us a few years to get here; but, I am now of the opinion that it is time to file for bankruptcy.” Writing that he had recently listened to a recent city budget debate at city hall—a debate during which the mayor castigated a Councilmember for daring to mention the “B” word – bankruptcy. The mayor said that she worried his comments could hurt the city’s credit rating, adding: “The pitiful financial state of the city is no secret. Anyone buying our bonds needs to have their head examined. A few years ago, we could have turned the corner, put responsible adults in charge, and attempted to rein in the city’s spending; but, we are way past that now. Houston is Greece.” As in other cities, the challenge is fiscal sustainability: how can the city address its long-term fiscal obligations? Mr. Hooper notes: “During the ‘special’ city council meeting called by three council members to discuss a firefighter union settlement, council member Jerry Davis suggested that, ‘We will just raise taxes to fix the debt problem.’ Senator Paul Bettencourt laughed and pointed to the facts: property taxes would have to be increased by fifty percent for ten years to pay off our current pension debt, assuming the city did not spend another dime.’” Then he wrote: “All city politicians are against bankruptcy, because they want to control the piggy bank. Filing for bankruptcy now allows us to regain control of our city after years of reckless spending, cuts off reckless spending, and allows us to renegotiate our union contracts. A Federal Bankruptcy Judge, responsible adult, would be making spending decisions…Politicians, bond lawyers, financial consultants, investment bankers, and municipal securities brokers have created a heck of a mess. Who is going to get us out? The answer begins with the “B” word – file for bankruptcy now.”

Responding to Municipal Fiscal Emergencies

Financial Emergency. Wayne County is in a financial emergency, the state’s five-member independent review team has concluded after less than three weeks of pouring over the county’s books. The finding, coming in response to the request of Wayne County Executive Warren Evans, by the Michigan Department of Treasury, indicated that Wayne County’s past four audits “revealed notable variances” between revenue and expenditures in the county’s $500 million general fund as first budgeted, then as amended, and then as actually realized. The response, while not unexpected, marked the first time in the state’s history for a county; nevertheless, it was a finding Mr. Evans had sought as a means to gain leverage in his efforts to move forward on his proposed recovery plan. Under a consent agreement with the state, which such a consent agreement would appear to provide, he is proposing to reduce employee benefits as part of an ambitious plan to achieve $230 million in spending cuts over the next four years. Under the review team’s own assessment, Wayne County is projecting a $171.4 million deficit by FY’2019. Yesterday’s finding now starts the stopwatch: Gov. Rick Snyder has ten days in which to declare an emergency—a declaration which, if he so makes, would trigger four options for Wayne County: a consent agreement, a state appointment of an emergency manager, a neutral evaluation, or municipal bankruptcy.

Highlights of the review team’s findings in its 18-page report:

  • Wayne County’s last four annual financial audits revealed notable variances between General Fund revenues and expenditures as initially budgeted, as amended, and as actually realized.
  • In addition, County officials underestimated actual expenditures in three of the fiscal years by amounts ranging from $16.7 million to $23.7 million;
  • Wayne County officials engaged in unbudgeted expenditures in violation of Public Act 2 of 1968, the Uniform Budgeting and Accounting Act;
  • although there was agreement among county officials that existing detention facilities are inadequate, there is no consensus about whether to complete construction on a new jail or to renovate existing facilities.

The state report also cited several other issues, including the county’s healthcare liabilities and underfunded pension system; the fact that county budget disagreements have often been resolved through litigation; and the one-time assessment that county property taxpayers are being forced to pay this summer in a pension case. The review team also mentioned ineffective communication as an issue in the county. As examples, they cited the lack of response unions said they had received from the county on their counter proposals to requests for concessions, as well as the fact that several county commissioners said they learned of Mr. Evans’ request for a state review through the media.

Because Detroit is part of Wayne County (Detroit accounts for 47% of Wayne County’s population as the largest of its 43 municipalities), Mr. Evans, prior to the state’s announcement yesterday, in his first ever appearance before Detroit’s City Council, testified that Wayne was not necessarily on its own path to municipal bankruptcy—but he did tell them the county was broke—so that the expected state declaration would open the way for the county’s elected leaders to vote upon the critical fiscal path to sustainability: “There’s no way I see Wayne County needing an emergency manager or bankruptcy at this point…We have a defined recovery plan that anyone can look at, and if this recovery plan is followed, then the structural deficit is gone…The county is in a significant financial situation, but the needle may move a little bit today [with the review team’s declaration]…The strength of the consent agreement is that it gives us the ability to impose on collecting bargaining agreements that have expired. The reality is, if we can’t [come to terms with the unions], we’re going to go off the edge of the bridge financially.” Mr. Evans’ presentation marked his first appearance before the council since he took office last January. In response, some Detroit council members, as well as some residents, warned that a consent agreement had been Detroit’s first step toward a full state takeover and eventual bankruptcy.

In a rejoinder, Detroit Council President Brenda Jones noted: “We did not ask for a consent agreement, but we got one…We were told if we followed it [we would remain in control], and we did, but guess what? We got an emergency manager…That’s probably why citizens are saying to you what they are saying, because it seems like déjà vu to some when they saw what happened in the city.” In response, Mr. Evans stated: “I say very, very clearly that that is absolutely untrue: Any problems we have is shown in our recovery plan, and how we get out of this is in our recovery plan, “ adding that his goal is to get the state in, but then to “hurry up and get them out: We don’t want them there lingering…I’ve spent over 40 years in Detroit and Wayne County, and I know we can fix our own problems. We’re halfway home, the problem with the rest of the way home is it’s the heavy lifting that can’t be done unilaterally by a county commission or executive’s office. It’s the powers conveyed in the consent agreement that at least gives us the leverage to finish.” In his presentation to the Council, Mr. Evans listed the county’s main financial problems: a $52 million structural deficit, a $900 million unfunded pension liability tied to a 45% funded plan, and a $1.3 billion retiree health care obligation. The health care liability makes up 40% of the county’s long-term debt: “There are significant liabilities out there, but if we get rid of the structural deficit we’re on a path to have a balanced budget and get our credit rating upgraded: We’re in government, you have to be able to borrow money, you have to be able to complete projects.”

Jailhouse Rock. During his session with the Detroit City Council, Mr. Evans address the notorious, half-finished jail project in downtown Detroit, which the county abandoned a year ago amid cost overruns and now cannot afford to finish, noting everyone wants to know what is going to happen to the jail: “The answer is, without a balanced budget and with our bond rating, I can’t do anything about it because whatever we’re going to do is going to take more money.” Indeed, the state report specifically pointed to the abandoned jail project and lack of agreement as to how to move forward as one of the several conditions that led to a determination of a financial emergency.

Preserving Autonomy. The Detroit City Council yesterday voted 5-4 to reverse itself and raise water and sewer rates 7.5%, responding to warnings from both city and state officials that failure to do so would generate additional state oversight of the city—and further derogation of its own authority. Michigan Treasurer Nick Khouri had warned the city leaders that rejecting the rates would mean the loss of $27 million out of a $79 million budget and likely trigger action by the state-appointed review board—and put in peril final negotiations of the Great Lakes Water Authority, a bond-issuing body that is poised to take over the Detroit Water and Sewerage Department—an agreement which still awaits bondholder approval, approval which might be difficult to gain were there a large budget shortfall. Perhaps more potently, Detroit COO Gary Brown warned prior to the vote: “If it doesn’t get done by Jan. 1, it falls apart….If you don’t approve the rate increase, the layoff notices are going to be going out: We need the rate increase in order to move forward and invest in this system.”

Adding Insult to Fiscal Injury.  Sometimes, when it rains, it pours: so it is that San Bernardino’s municipal leaders yesterday learned that the San Bernardino Employment and Training Agency (SBETA) is likely to be found ineligible for reimbursement of $1.2 million the city had counted on—an adverse surprise that could well spell the doom of the 40-year-old agency. Nevertheless, the bankrupt city’s City Council voted 4-3 to appropriate $135,000 out of the city’s general fund — funds sufficient to keep the center open for one month — and then meet again next week to assess possible options—a decision that temporarily protects not just ten full-time and fifteen part-time jobs, but, possibly more importantly, insures the agency can continue to provide job placement and other counseling services. But the harsher fiscal message from the Executive Director of the California Workforce Investment Board to Mayor Carey Davis appears to mean that the city’s hopes of recouping the $1.2 million it has already expended for the agency will be unmet—and that any hopes for future assistance have gone up in smoke. While the city can appeal, Councilman Fred Shorett said he had spoken to officials at both the county and state level, reporting: “I believe that the die is cast, and there is no hope of keeping SBETA alive. At this point, we’re just throwing good money after bad…We talk about ‘fiscal sanity.’ This is fiscal insanity. When we’re closing fire stations, we’re not funding other things you’d like, yet we fund this with money we don’t have.” The state placed the cash hold on the city, because San Bernardino was overdue on its FY2013 audit—a very overdue audit, which the city’s accounting firm, Macias, Gini and O’Connell LLP, this week indicates could be completed by the end of this week.

What Happens when the Money Runs Out?  Puerto Rico’s approved budget allocation for appropriation and Government Development Bank for Puerto Rico debt is just under 20% short of the amount requested by the Governor Padilla, likely guaranteeing a missed debt service payment by Puerto Rico Public Finance Corp. as early as today. The likely non-payment comes as the working group for the economic recovery of Puerto Rico is seeking to cobble together recommendations with regard to how the U.S. territory could distribute a reduction of $63 million to its appropriation debt holders at the end of next month—recommendations which will be subject to approval by the legislature, according to a spokesperson in the Puerto Rico Senate. In the nonce, the missed debt service by Puerto Rico Public Finance Corp. signaled the likely default as early as next week on a payment due—a default which would mark the first monetary default by Puerto Rico and the beginning of the unprecedented process of trying to restructure as much as $72 billion in debts outside of a federal bankruptcy court. That is, absent action by Congress, Puerto Rico is now entering an uncharted fiscal Twilight Zone—as are its millions of municipal bondholders. In addition to some $275 million for appropriation and Government Development Bank debt, the island’s budget allocated $1.011 billion for general obligation debt, $117 million for commonwealth-guaranteed Administration for Infrastructure Financing debt, $46 million for the last payment for the FY2014-2015 tax and revenue anticipation note, and $26 million for some other debts, according to the Puerto Rico Office of Management and Budget. A key issue is whether holders of Puerto Rican debt have any legal recourse—or, as one expert notes: For Puerto Rico’s perspective: “[D]efaulting on appropriation debt would be the least painful way to conserve cash as the government can claim it has no obligation to appropriate…Based on our reading of the bond documents, the bondholders have no right to compel payment.” That is, even though Puerto Rico has taken difficult fiscal steps to increase revenues by hundreds of millions of dollars, while at the same time reducing expenditures by hundreds of millions of dollars in its recently approved budget; the steps are woefully short of the fiscal chasm that now make clear defaults could commence as early as September.