The Burdens & Risks of Default

Charting and Charters. Wayne County Commissioners have raised questions with regard to whether Wayne County Executive Warren Evans’ plan to reorganize departments violates the county charter. Mr. Evans’ plan is intended to save the fiscally challenged municipality $3 million annually through the consolidation of three departments and a division—savings critical to a sustainable fiscal future in a county confronting a $70 million annual structural deficit stemming from an underfunded pension system and a $100 million drop in property tax revenues since 2008. Thus, should the Commission, when it reconsiders the issue next week, determine the plan does violate the charter, it would mark a considerable setback to the County Executive’s efforts to avoid municipal bankruptcy. Under the proposed plan, Children and Family Services, Health and Human Services, and Senior and Veterans Services would be combined into a new department: the Health, Community Wellness and Senior Services Department. But there is the rub, or, as Wayne County Commission Chairman Gary Woronchak puts it, with “senior and veterans services being put under the new consolidated department, but the charter calling for (Senior Services) to be a separate department, how do we reconcile moving the Senior Services Department to division status without violating the charter?” In response, Assistant Wayne County Executive Genelle Allen said the administration believes the charter permits the consolidation, explaining that, under the proposal, there would still be a department—simply one with expanded “duties and responsibilities. We have a legal opinion that the move doesn’t violate the charter.” Under the plan, the county’s Department of Economic Development Growth Engine would be incorporated as part of the Wayne County Economic Development Corp., a quasi-public agency modeled after the Michigan Economic Development Corp. and the Detroit Economic Growth Corp—a move which would include the reduction of 50 jobs.

Puerto Rico: A Perfect Storm. Puerto Rico’s development bank has warned that the U.S. territory is in danger of a total government shutdown without a significant liquidity infusion, with its leaders warning Governor Alejandro Padilla that the territory was not projected to have enough money to pay its bills in the near future: “We’ve said on repeated occasions during the past few months that, despite the efforts of this administration, the financial condition of the commonwealth is extremely precarious.” The epistle warned that a government shutdown is likely within the next three months absent a substantial source of new liquidity. If anything, the fiscal crisis has accelerated in the wake of the rejection by Puerto Rico’s House of Representatives of a VAT or value added tax which would have brought in hundreds of millions of dollars more in the coming fiscal year. Puerto Rico Gov. Alejandro García Padilla is planning to propose a 10.4% cut in spending in the coming year’s budget—or close to a billion dollars, dropping next year’s proposed budget from the current $9.56 billion down to $8.6 billion, as part of his effort to propose a balanced budget prior to the beginning of the territory’s new fiscal year on July 1. His key staff are meeting with department heads now in intense negotiations about how to perform such fiscal surgery: Gov. Padilla is hoping to avoid any significant reductions in the portions of his proposed budget affecting security, health, and education; he maintains that all are parts of the current budget are on the table. What is less certain is what tax revenues may be relied upon: The current budget benefits from $344 million in capitalized interest from Puerto Rico’s March 2014 general obligation bond sale, which left $75 million in capitalized interest for FY2016: through the end of March this year’s tax collections were $153 million short of projections, and anticipation is that the last quarter’s revenue collections could be $100―$200 million less than projected. The winnowing down of revenues is projected to hit just as the island’s debt service costs are projected to rise—an expenditure which, because it is guaranteed by the Puerto Rico constitution, means the island could face an increase of as much as $325 million or 26%, including both general obligation and appropriation debt. Moreover, Puerto Rico’s Treasury officials have warned that there will be greater pension obligations to meet—with the combined mandatory pension obligations and reduced revenues forcing the significant cuts in discretionary spending—cuts now expected to be well above the planned 10.4% to achieve a balanced budget. Puerto Rican officials have warned that after nearly a decade of economic stagnation, moreover, that the rejection of the proposed tax reform efforts has endangered a $3 billion issuance of energy-tax-secured revenue bonds to boost liquidity at the Puerto Rico Government Development Bank, the Territory’s lender of last resort. With some $73 billion in debt, Puerto Rico’s central government is caught between Scylla and Charybdis: its debt-laden public corporations versus honoring its obligations to its GO municipal bondholders in every state across the country. Lawmakers have sought to “ring-fence” public corporations like the Puerto Rico Electric Power Authority to isolate its financial troubles from the rest of the public sector, but the tension between maintaining resources to provide essential public services versus meeting obligations to its municipal bondholders is running out of time.

The Burdens & Risks of Default. Even as Congress appears deaf to Puerto Rico’s plight, some 34 hedge funds that hold $4.5 billion in Puerto Rico sovereign debt are lawyering up, as are municipal bond insurers, albeit not necessarily in the best interests of the island’s U.S. citizens. A spokesperson for a so-called ad hoc group of creditors, which includes funds like Centerbridge Capital Partners LP and Monarch Alternative Capital LP, said a hedge fund group was covering all its bases in case there was a fight to come, as the territory is seeking to revive a restructuring law that would allow it to shed some of its $73 billion in debt more easily. Some 34 hedge funds, funds which hold Puerto Rican government guaranteed and tax supported municipal debt, claim they are “committed to working with the Commonwealth to provide financing that can bridge Puerto Rico to a balanced budget and growing economy…” But the group adds that, “given the lack of progress thus far to achieve this objective, we are simply preparing for all potential outcomes.” Similarly, municipal bond insurers, such as Assured Guaranty and MBIA, and others, which currently insure about $14 billion of the island’s $72 billion in outstanding municipal debt—but the lack of disclosure has been making it difficult to assess exactly how comprehensive that insurance is, is raising further questions about the potential implications of a municipal default. Thus, while Puerto Rico—so far denied access to the federal protections of municipal bankruptcy—has been in negotiations with its creditors, these are negotiations without the oversight of a U.S. Bankruptcy court. There is a scent of hyenas.

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