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.”