June 30, 2015
Is Puerto Rico at the Tipping Point? Puerto Rico Gov. Alejandro García Padilla yesterday praised a report, “Puerto Rico—a Way Forward,” by Anne Krueger, Ranjit Teja, and Andrew Wolfe—which calls for a comprehensive solution to Puerto Rico’s problems, including debt restructuring. The report, which Puerto Rico commissioned, calls for fiscal adjustment, structural reforms, and debt restructuring. As for the latter, the authors say that even after Puerto Rico took major revenue and expenditure measures, there would be large financial gaps. These would peak at about $2.5 billion in fiscal 2016 and generally decline to about $0 in fiscal 2024. By comparison, the total commonwealth government debt service in fiscal 2016 is slated to be about $3.6 billion. The report notes: “Debt relief could be obtained through a voluntary exchange of old bonds for new ones with a later/lower debt service profile. Negotiations with creditors will doubtlessly be challenging.” They make clear the general obligation as well as other commonwealth government debt should be restructured. The authors also call for negotiations on the public corporations debt and for the federal government to make the corporations eligible for Chapter 9 bankruptcy.
The report warns that Puerto Rico will need to seek relief from principal and interest payments falling due from 2016 to 2023; however, it also warns that any restructuring of general obligation, or central government debt, would set a precedent as “no U.S. state has restructured (such debt) in living memory,” and any such attempt would face legal challenges—even as it made clear there are limits with regard to how much more expenditures can be cut or taxes raised. Or, as Adam Weigold, senior portfolio manager at Eaton Vance, put it last Friday: This coming week “is the tipping point:” Puerto Rico’s debt problems could lead to a reduction in government services. Nevertheless, Reuters noted that the island is not contemplating a partial or full shutdown of government services. With some of Puerto Rico’s creditors, restructuring negotiations are already underway: late last week, Puerto Rico officials and creditors of the island’s electric power authority were apparently close to a deal which would avoid a default on a $416 million payment due the day after tomorrow, and, with other payment deadlines looming, Gov. Padilla and his staff said they would begin looking for possible concessions on all forms of government debt.
The key takeaways from the report:
- This is a problem years in the making;
- The problems are structural–not cyclical;
- This is a “vicious cycle” where unsustainable public finances are feeding uncertainty and low growth;
- “failed partial solutions argue for a comprehensive approach;
- “[the]single most telling factor is that 40% of the adult population — versus 63% on the mainland — is employed.” Why? Because the minimum wage; local overtime, paid vacation, benefits are too costly to the governments—and to the 147 municipalities; local welfare benefits are more generous than the minimum wage.
- Public sector debt has risen each year–reaching 100% of GNP by the end of FY’14;
- “If federal obstacles could be overcome, there is no reason why Puerto Rico could not grow in new directions…”
June 29, 2015
More Trouble in River City. A critical issue for any municipality is an audit; that is even more the case when a city or county files for bankruptcy: it provides that outside review important to the city’s taxpayers, the federal bankruptcy court, and the municipality’s creditors. While an audit, technically, is not necessarily required by San Bernardino’s charter committee, City Attorney Gary Saenz had warned that failure to have those audits by the deadline would be “devastating for the city.” City Manager Allen Parker had agreed, last spring, with council members who said its absence in the city’s plan of debt adjustment would allow San Bernardino’s creditors to attack the plan before the federal court as unprepared and undeserving of bankruptcy protection. Notwithstanding that apprehension, Deputy City Manager Nita McKay has now confirmed the audit has not been completed, and, obviously, not been included in the city’s plan of debt adjustment. Worse, the city’s accounting firm, Macias, Gini and O’Connell LLP, not only has missed repeated deadlines, but had also requested nearly half a million dollars—more than double its original cost estimate given to the city—to complete it. Unsurprisingly, the attorney representing San Bernardino’s municipal bondholders had charged in U.S. Bankruptcy Judge Meredith Jury’s first hearing earlier this month that San Bernardino had failed in its duty to the court and the city’s creditors by not even disclosing that its plan of debt adjustment did not mention the missing audits—either in its submitted plan or in its testimony before the court. Nor, the attorney charged, had the city proposed a hearing date at which Judge Jury could consider the adequacy of San Bernardino’s financial disclosure statement. For her part, Judge Jury has noted that a bankrupt entity normally would have proposed such a date to keep momentum in the case. Instead, Judge Jury set the hearing date for October 8th. The problem appears to lie not just with the city’s auditor, Macias, Gini and O’Connell LLP accounting firm, but also with the city’s own transparency and at least perceived competency. While there is every indication San Bernardino staff have been responsive to every request from the auditor—according to the auditor; as late as last Thursday, the firm’s audit managers gave the city staff a new list of outstanding items—a list city staff described as one which “contains 29 items, 24 of which have not been requested before the time of the meeting…For eight of these items, they could not articulate what it is that they are requesting, i.e. ‘changes to General Fund accounts receivable resulted in additional testing being needed for $3.7 million. Sample to follow.’” San Bernardino Councilmember Fred Shorett at the end of last week stated the seemingly obvious: the city might need to consider starting over with a new firm, even though that would present difficulties: “This sounds as though this auditing firm is incompetent or (not) working…Giving no responses to you and coming at us with requests at the eleventh hour is not acceptable. This whole situation needs review. I’m very concerned that this firm has some kind of agenda that is not helpful to us.” Councilman Rikke Van Johnson also questioned the firm’s motives. “Sounds as if they are playing us and trying to get more money!” he wrote. The auditing firm is surely on notice that, despite its 13th hour demands for a significant increase in payments for a job not done, it is requesting said increases as, now, one of many creditors in bankruptcy—it will not be paid one hundred cents on the dollar—but its integrity and competence, as well as the failure of the city to oversee—or disclose—the absence seem hardly likely to curry respect from Judge Jury.
Is Puerto Rico at the Tipping Point? With the increasing likelihood that Congress will continue to ignore the U.S. territory of Puerto Rico’s looming insolvency—or even give Puerto Rico the ability and authority to offer its 147 municipalities access to chapter 9 municipal bankruptcy, Puerto Rico Governor Alejandro García Padilla stated: “My administration is doing everything not to default…But we have to make the economy grow…If not, we will be in a death spiral.” Gov. Padilla has now conceded the commonwealth cannot likely pay its nearly $72 billion in outstanding debts, warning the island is in a “death spiral,” but, unlike any other U.S. corporation, denied access to the federal bankruptcy courts.
Puerto Rico needs to restructure its debts and should make reforms, including cutting the number of teachers and raising property taxes, a report by former International Monetary Fund economists on the Caribbean island’s financial woes said. Gov. Padilla, and senior members of his staff said last week that they would probably seek significant concessions from as many as all of the island’s creditors, which could include deferring some debt payments for as long as five years or extending the timetable for repayment: “The debt is not payable…There is no other option. I would love to have an easier option. This is not politics, this is math.” Gov. Padilla is also likely to release a new report today by former IMF economists, who were hired earlier this year by the Puerto Rico Government Development Bank to analyze Puerto Rico’s economic and financial stability and growth prospects—a report concluding that Puerto Rico’s debt load is unsustainable. The report suggests a municipal bond exchange, with the new bonds carrying “a longer/lower debt service profile,” noting that: “There is no U.S. precedent for anything of this scale or scope.” The report is not solely focused on Puerto Rico, however, but also seems aimed at the White House and Congress—neither of which appear to be willing to devote time or resources on these events affecting hundreds of thousands of Americans, although both New York Federal Reserve leaders and United States Treasury officials have been advising the island’s government in recent months amid the worsening fiscal situation.
Said report, according to Reuters, recommends structural reform and debt restructuring, writing: “Puerto Rico faces hard times…Structural problems, economic shocks, and weak public finances have yielded a decade of stagnation, out-migration, and debt… A crisis looms.” The report recommends restructuring of Puerto Rico’s general obligation debt, as well as suspending the minimum wage and reducing electricity and transport costs, noting the U.S. territory must overcome a legacy of weak budget execution and opaque data.
Seemingly overwhelmed by its staggering $73 billion debt load and faltering economy—and with its Government Development Bank running out of cash, Puerto Rico this week has a number of municipal bond payments coming due—even as its public power utility, PREPA, is in talks to avoid a possible default. The report warns that Puerto Rico will need to seek relief from principal and interest payments falling due from 2016 to 2023; however, warning that any restructuring of general obligation, or central government debt, would set a precedent as “no U.S. state has restructured (such debt) in living memory,” and any such attempt would face legal challenges—even as it made clear there are limits with regard to how much more expenditures can be cut or taxes raised. Or, as Adam Weigold, senior portfolio manager at Eaton Vance, put it last Friday: This coming week “is the tipping point:” Puerto Rico’s debt problems could lead to a reduction in government services. Nevertheless, Reuters noted that the island is not contemplating a partial or full shutdown of government services. With some of Puerto Rico’s creditors, restructuring negotiations are already underway: late last week, Puerto Rico officials and creditors of the island’s electric power authority were apparently close to a deal that would avoid a default on a $416 million payment due the day after tomorrow, and, with other payment deadlines looming, Gov. Padilla and his staff said they would begin looking for possible concessions on all forms of government debt.
The ever perceptive Mary Walsh Williams of the New York Times this morning notes “Puerto Rico’s municipal bonds have a face value roughly eight times that of Detroit’s bonds.” That is, as she wrote, Puerto Rico’s fiscal meltdown and inability to access U.S. bankruptcy courts could have fiscal implications for cities and counties throughout America, writing: “Its call for debt relief on such a vast scale could raise borrowing costs for other local governments as investors become more wary of lending. Perhaps more important, much of Puerto Rico’s debt is widely held by individual investors on the United States mainland, in mutual funds or other investment accounts, and they may not be aware of it. Puerto Rico, as a commonwealth, does not have the option of bankruptcy. A default on its debts would most likely leave the island, its creditors, and its residents in a legal and financial limbo that, like the debt crisis in Greece, could take years to sort out.” She writes that Puerto Rico must set aside as much as $93 million each month to pay the holders of its general obligation bonds — a critical action, because Puerto Rico’s constitution requires that interest on its municipal bonds—payments which go to citizens in every state in the U.S.—be paid before any other expense, adding that “No American state has restructured its general obligation debt in living memory.” The government’s Public Finance Corporation, which has issued bonds to finance budget deficits in the past, owes $94 million on July 15. The Government Development Bank — the commonwealth’s fiscal agent — must repay $140 million of bond principal by Aug. 1.
Here Come da Judge. It turns out that even though Congress appears determined to bar Puerto Rico from access to the U.S. Bankruptcy Court, Puerto Rico is creating its own wise investment, this month hiring retired U.S. Bankruptcy Judge Steven W. Rhodes, who presided over the largest municipal bankruptcy in U.S. history in Detroit’s 18 month municipal bankruptcy. In addition, Puerto Rico is also consulting with a group of bankers from Citigroup who advised Detroit on a $1.5 billion debt exchange with certain creditors. The ever electronically and musically perceptive Judge Rhodes told Ms. Williams that Congress needs to go further and permit Puerto Rico’s central government to file for bankruptcy — or risk chaos, telling her in an interview: “There are way too many creditors and way too many kinds of debt…They need Chapter 9 for the whole commonwealth.”
June 25, 2015
Not My Problem. A unique characteristic of the United States and federalism is dual sovereignty, making the U.S. and its kind of federalism unique among all nations. In the field of bankruptcy, it means Congress lacks Constitutional authority to even grant authority to states to file for bankruptcy; similarly, the federal government cannot grant municipalities such authority—except by means of authorizing states to, as is done under chapter 9. Unsurprisingly, then, not only do not all states authorize municipalities to file for municipal bankruptcy, but among those that do, virtually no two provide such authority the same way. Moreover, as we have noted, not only the differing statutes, but also the state role in those states where municipalities have filed for chapter 9 municipal bankruptcy, has been profoundly different. Key issues have related not only to whether, under such state authorizing legislation, the state asserts authority to preempt local authority by means of the appointment of a receiver or emergency manager—appointments which have meant suspension of any authority for the elected leaders of a city or county, but also the role of the state in contributing in some way to the development and implementation of an ensuing plan of debt adjustment—the plan which must be approved by a U.S. bankruptcy court for a city or county to successfully exit bankruptcy. U.S. Bankruptcy Judge Thomas Bennett keenly noted the precipitate role of the State Alabama in leading to Jefferson County’s bankruptcy, while in Michigan, Gov. Rick Snyder gradually began coordinating with key bipartisan leaders of Michigan’s House and Senate in making critical contributions to Detroit’s plan of debt adjustment—granted with some exceptionally innovative and creative contributions by U.S. Chief Judge Gerald Rosen. So it is that, unlike municipal bankruptcy in any other country around the world, states not only have a role under the U.S. Constitution, the federal municipal bankruptcy law, but also the unique politics and leadership within each state.
Ergo, mayhap ironically, California appears to be set on the Alabama model—spurning the more constructive roles taken by Rhode Island, Michigan, New Jersey, and Pennsylvania. If anything, that message appeared to be reinforced yesterday when Gov. Jerry Brown offered no positive reinforcement to San Bernardino’s Mayor Carey Davis in his quest to the state capitol in Sacramento. Mayor Davis, notwithstanding the absence of any affirmative state role in the municipal bankruptcies of Vallejo or Stockton, nevertheless had made the long trip just in case.
It was time and resources, scarce commodities for a city in bankruptcy, apparently for naught. Gov. Brown’s response, according to the city, was no. The key issue – ironically in the midst of the surge of the so-called sharing economy – was sharing vital public services. Or, as Mayor Davis’ chief of staff, Christopher Lopez, put it: the “cornerstone” of San Bernardino’s plan of debt adjustment pending before U.S. Bankruptcy Judge Meredith Jury is contracting out for some services, including fire protection. Specifically, the city has pressed for the 110-year old California state agency Cal Fire to submit a bid for providing fire services to San Bernardino—part of the city’s plan to contract out such services, and something the city has repeatedly sought to pressure Cal Fire to provide. Given the lack of any response, the delegation yesterday sought a prod from Gov. Brown—a prod which produced, apparently, not even a spark, or, as Mr. Lopez put it: “Governor Brown’s office has recently made San Bernardino aware that Cal Fire will not provide a proposal and that our additional requests will not be considered.” In contrast, the San Bernardino County Fire Department and a private firm, Centerra, have each submitted proposals to provide San Bernadino’s fire services—bids which the city guesstimates could save it as much as $7 million annually. Having struck out on the fire front, the Mayor and delegation then sought assistance on other key items on their list, including some relief from a potential California Public Employees’ Retirement System penalty, the threatened decertification of the San Bernardino Employment and Training Agency, a loan, help with the dissolution of the city’s redevelopment agency, and clarification on its tax agreement with Amazon. They went home empty-handed.
Send for Batman! In most instances, in the case of a potential drowning, a lifeguard at least throws a buoy, but in the wake of Wayne Count Executive Warren Evans’ request for Michigan state intervention, Standard & Poor’s put the county’s speculative grade rating on CreditWatch with negative implications yesterday. The downgrade will increase costs for the fiscally struggling county; the harder question is what S&P’s actions might mean to the many municipalities, including Detroit, within its boards. Jane Ridley, S&P’s analyst, wrote: “The CreditWatch placement reflects our expectation that with the onset of actions under Michigan Act 436, the county could lose some of the autonomy currently held by the CEO and his staff.” Ironically, Mr. Evans’ June 17th request was intended to enable the county to enter into a consent agreement with the state (please not the stark contrast with the seeming lack of any intergovernmental commitment in California, above) to enhance Wayne County’s authority to deal with labor contracts and other pending issues critical to the county’s fiscal sustainability—and, as state officials have made clear, municipal bankruptcy or even the appointment of an emergency manager is not only not in the picture, but also Michigan state officials almost immediately made most clear that municipal bankruptcy is not only not in the picture, but also that they perceive Mr. Warren’s request as a positive, constructive step towards resolution of Wayne County’s fiscal challenges. Nonetheless, in its warning, S&P noted that under Michigan law, if the county’s request were approved by the state for a financial review, the Wayne County board would be faced by four options: a consent agreement; appointment of an emergency manager; a neutral evaluation; or it could pursue a Chapter 9 bankruptcy filing, with Ms. Ridley writing: “In our view, the county’s request for financial review does not signal the start of filing for bankruptcy, but rather a step in its stated goal of using all possible tools to regain structural balance…However, given the uncertainty associated with these four options—as well as the potential for a prolonged time frame to make additional meaningful structural changes while this process is underway—we have placed the rating on CreditWatch,” adding that its actions reflect apprehensions Wayne County’s autonomy in its restructuring could be diminished if an emergency manager is ultimately named: “In our view, this could mean that making the significant, meaningful adjustments necessary could be delayed or adjusted, which would have an impact on the county’s long-term financial health.” If, instead, Wayne County retains control over its restructuring, as seems to be not only its intent, but also the state’s impression, S&P noted it could remove the rating from CreditWatch and assign a negative outlook, reflecting the long-term budget pressures the county is facing. Interestingly, in light of the discussion re: federalism above, Ms. Ridley notes that S&P views the appointment of an emergency manager as more risky due to the loss of autonomy—a loss the credit rating agency notes which could lead to a credit rating downgrade: “Notwithstanding the uncertainty of the county’s near-term management control, without the county’s clear, demonstrable progress in the next year to regain structural balance and reduce its sizable pension burden, we could lower the rating…In addition, should Wayne County’s liquidity position deteriorate significantly, we could lower the rating.”
Trying to Balance its Budget. The Puerto Rican Senate is currently considering the U.S. territory’s FY2016 budget—a balanced budget, like every state in the U.S., albeit unlike any Congressional budget in modern times, which the House adopted and sent to the Senate early this week, and which includes austerity measures to improve Puerto Rico’s fiscal health. As passed, the House budget estimates $9.8 billion in revenues, and proposes $9.55 billion in spending. The House proposed $674 million in spending cuts, with much of the savings to anticipate the territory’s increasing debt service costs and public pension obligations; the House cut nearly 60 percent off the Puerto Rico Development Bank’s budget request of $700 million—with the bank facing potential insolvency later this summer when some $4 billion in debt it issued begins to become due. The House Chairman of Committee on Treasury and the Budget, Rep. Rafael Hernández Montañez, noted the development bank could be forced to restructure its debt, but that the House-passed budget would be sufficient to ensure Puerto Rico would not default on any of its general obligation or G.O. bonds, albeit, he warned that if the U.S. territory’s development bank encounters difficulties in meeting its obligations and is forced to restructure its debt, there might have to be some delay in setting aside the proposed funding in the House-adopted budget to meet pending general obligation bond payments—warning that the alternative would be a government shutdown—an alternative he made clear would be devastating to the island’s economy.
In the Fiscal Twilight Zone. Even as Puerto Rico’s elected leaders have been pressing to address the U.S. territory’s overwhelming debts—and hedge funds have mounted an expensive lobbying and advertising campaign with full page adds—“No Bailout for Puerto Rico”—in the Wall Street Journal as part of a heavily financed lobbying blitz in the U.S. Congress to bar granting Puerto Rico the same authority provided to every state in the U.S., or even broader authority so that the U.S. Bankruptcy courts could act to ensure the continuity of essential public services while overseeing the development of a plan of debt adjustment; Congress so far has been seemingly paralyzed—and it is focusing its attention in a diverting way, so that Puerto Rico’s Governor, Alejandro García Padilla, is urging Congress to act on pending legislation to give the U.S. territory access to municipal bankruptcy authority—and not divert its focus to the issue of potential statehood. The urgency came this week in the face of continued inaction by the House Judiciary Committee, but, instead, a hearing yesterday by the House Committee on Natural Resources Subcommittee on Indian, Insular and Alaska Native Affairs on proposed legislation to authorize a means for Puerto Ricans to determine what legal options might be available for its citizens to opt for statehood. Even with the U.S. territory nearing a potential default and insolvency, Chairman Don Young (R-Alaska) had scheduled the hearing earlier this month to consider legislation proposed by Rep. Pedro Pierluisi (D-P.R.) to authorize a U.S. sponsored vote to be held in Puerto Rico within one year of its enactment: the vote suggested in the bill would be solely on the question with regard to whether Puerto Rico should become a state—a status which, were it to be adopted, would render Puerto Rico not only able to authorize its 147 municipality’s the option to file for chapter 9 municipal bankruptcy, but also make the state-to-be eligible for billions of dollars in additional annual federal funding. Rep. Pierluisi stated: “I don’t seek special, different or unique treatment…I don’t ask (for Puerto Rico) to be treated any better than the states, but I won’t accept being treated any worse either. I want only for Puerto Rico to be treated equally. Give us the same rights and opportunities as our fellow American citizens, and let us rise or fall based on our own merits. Because I know that we will rise.” He testified of his apprehensions that, absent statehood, he worried there would be a continuing exodus of intelligent workers to the U.S. mainland in search of full rights available in the 50 states. Puerto Rico Attorney General César Miranda, testifying on behalf of Gov. Padilla, urged Congress to focus on the immediate, “truly dire” situation: Puerto Rico’s “state of fiscal emergency,” telling the Committee that diverting attention to the issue of authorizing a mechanism for considering statehood should await resolution of the island’s most crucial issue: granting bankruptcy authorization rights to the island: “We have the capabilities to come across and bring the island to a brighter condition…We need to have an instrument to deal with the debt that we are carrying now. That is why we support extending Chapter 9 to Puerto Rico.”
The GMU Municipal Sustainability Project 