The winnowing of retiree healthcare costs

Many state and local governments have promised to provide healthcare benefits for their retirees. These benefits cover retirees before they reach the eligibility age for Medicare and those who are Medicare ineligible. The promises include additional Cadillac benefits to retirees who are eligible for Medicare and provided supplemental coverage. These promises are known by their accounting moniker, OPEBs (other post employment benefits).

Few governments have set aside funds to pay for these promises, leaving an enormous unfunded liability that will burden future municipal budgets. Every government is responsible to meet their promises. Moody’s analyst Marcia Van Wagner wrote about the size of the OPEB juggernaut:

States listed a total of more than $530 billion in unfunded OPEB liabilities in their fiscal 2012 financial reports, although the liabilities are highly variable and concentrated within a subset of states.

Moody’s says the unfunded liability is about equivalent to state tax-supported debt. Unlike bonded debt though, OPEBs are being reduced and in some cases have been eliminated by bankruptcy in cities like Stockton, California. Detroit replaced retiree healthcare coverage with a small monthly check. Moody’s writes about other, less onerous steps that governments have taken to rein in costs and benefits:

Surveys indicate that state and local governments have widely pursued initiatives to contain retiree health costs. About two-thirds of governments responding to surveys cited by the Center for State and Local Government Excellence indicated that they had made changes to retiree health care in recent years, with the most common changes being increases to retiree premium contributions, co-payments and deductibles.

Puerto Rico’s local Chapter 9

Senate Bill 993 was recently proposed in the Puerto Rico Senate to create a mechanism for public corporations to be restructured. Since Puerto Rico is a commonwealth of the United States, it is excluded from Chapter 9 municipal bankruptcy code. There is currently no legal framework for a reorganization of liabilities. The legislation would establish such a framework.

Late Friday night (9:30 pm EST) the government issued a statement denying that they had any involvement in drafting the legislation:

In response to market speculation regarding Senate Bill 993, filed yesterday in the Puerto Rico Senate, which seeks to establish a legal mechanism to restructure the public debt of the Commonwealth’s public corporations, the Government Development Bank for Puerto Rico (GDB) and the Treasury Department wish to clarify that neither the GDB nor the Executive Branch proposed, reviewed, authorized or were in any way involved in the drafting or formulation of this legislation.

Puerto Rico’s local Chapter 9, a good start

This is a guest post by Puerto Rico attorney John Mudd. He writes about the new legislation filed in the Puerto Rico Legislative Assembly to allow the restructuring of public corporations.

Yesterday, Senators Nadal Power and Rosa Rodríguez filed a proposed act by which PR’s public corporations could reorganize its debts or even liquidate themselves. Essentially a local Bankruptcy Chapter 9. Both should be congratulated for having the moral fortitude to admit this must be considered. The preamble correctly indicates that state law may regulate those areas where Federal Bankruptcy law is silent or those entities excluded from the Bankruptcy Code, such as insurance companies or Puerto Rico’s municipalities and public corporations, expressly excluded via 11 U.S.C. § 101 (52). Moreover, the liquidation procedure of the P.R. Civil Code, Articles 1811-29, 31 L.P.R.A.  §§ 5171-5214 is totally obsolete since it dates back to the 19th Century.  In addition, the Preamble to this Act states that it is obsolete, making this a special law that preempts the more general law of the Civil Code.

The piece is a good start but lacks many of the necessary statutes that makes the Federal Bankruptcy Code a unique tool. Moreover, it should include the island’s municipalities, most of which are insolvent. In addition, it would make some sense for the law to require that some of the Commonwealth Courts be set for this type of procedure which will elicit massive litigation once it is started. Also, its judges should be especially trained in bankruptcy and dispute resolution since at this time the Puerto Rico bench is devoid of such knowledge. Now I will go to the specific areas that need to be added to the law. For your reference, I include English and Spanish versions but the statute states that the English version will prevail in case of doubt.

Puerto Rico after financing

Puerto Rico brought its long awaited bond offering to market last Tuesday for $3.5 billion, the full amount that was authorized by the Legislative Assembly. Underwriters had talked about the deal as $3 billion, but it seemed obvious given the liquidity needs of the Government Development Bank that it would be upsized it to the full legislatively authorized limit. The bond was structured to mature in 2035 with a 2020 par call.

The deal was priced with an original issue discount of $93 and an initial offering yield of 8.727 percent. This yield was approximately 95 basis points more than secondary market trading for Puerto Rico 2035 general obligation maturity, but in line with with secondary market yield for the bond’s single call par maturity of 2020, according to Thomson Reuters Municipal Market Data.

Puerto Rico’s yield curve has been inverted for several months and the deal seems to have been priced to its par call in 2020, which was trading with a higher yield than 2035 maturities. Reuters reports:

State tax revenues slip back to slower growth

The Rockefeller Institute said in a note about fourth-quarter state tax revenues that revenues continue to be positive, but they have slowed from the first half of the year. Personal income taxes made up about 41 percent of total state tax revenue in the fourth quarter of 2013 and slowed considerably from the first half of the year. Rockefeller writes:

The state personal income tax revenue picture in the first two quarters of calendar year 2013 represented the strongest growth since the start of the Great Recession. However, the growth in personal income tax collections softened in the third quarter of 2013 and was a mere 1.0 percent in the fourth quarter of 2013.

Personal income taxes are the bedrock of state tax revenues. But state sales taxes are also important and showed nice, steady gains. From Rockefeller again:

Deep in the public pension weeds

Most discussion about public pensions revolves around the levels of funding that governments report in their Comprehensive Annual Financial Statements (CAFRs). It’s a means of taking the temperature on the health of the pension fund.

To get these numbers, actuaries do some complicated math that projects the lifetime earnings of the public employees in the plan. They also calculate how much funding the sponsor government must contribute, how much payout retirees will receive and they make projections on how the investments owned by the pension funds will perform over time.

Like most financial modeling, the math is based on numerous assumptions — some which are accurate over time and some of which vary from actual results.

New bonds in the time of the inverted yield curve

Just a few more data points on the upcoming $3 billion Puerto Rico general obligation sale expected to price on Tuesday, March 11. Note the yield curve remains inverted and likely will offer some very high yields to investors lucky enough to win bonds maturing in 2022 through 2025 (red box marks the maturities listed in the tentative sinking fund schedule below).

Here is the most recent preliminary official statement (March 6, 2014).

Here is the tentative sinking fund schedule:

The dollar amounts of the use of proceeds has not been detailed yet, but here are the broad uses (page 23):

An important part of the use of proceeds is repaying some of the deal underwriters for various short term financings and swap termination payments to Morgan Stanley, Goldman Sachs and Bank of America Merrill Lynch (page 23-24):

Don’t let Chicago’s crisis go to waste

Moody’s cracked the whip and downgraded the rating of Chicago’s general obligation bonds to Baa1 from A3 this week. It’s only a one-notch downgrade, but no American city should wear the scarlet letter of BBB. Chicago’s Mayor Rahm Emanuel is seemingly frozen in place and having a tough time addressing the city’s fiscal problems. His behavior belies his famous 2009 quip to never let a serious crisis go to waste.

Moody’s in its rating comment about the city’s $8.3 billion general obligation and sales tax debt seems to think Chicago is in pretty rough shape:

The negative outlook reflects our expectation that, absent a commitment to significantly increase revenue and/or materially restructure accrued pension liabilities to reduce costs, the city’s credit quality will likely weaken. The formidable legal and political barriers to these actions are incorporated in the outlook.

Puerto Rico’s perfect storm


Two critical documents related to Puerto Rico’s upcoming $3.5 billion general obligation bond offering have been released: A draft of the preliminary official statement (POS) for the general obligation bond underwriting and a special liquidity update from the Government Development Bank (GDB).

Both documents contain new financial information and a laundry list of risks for potential bondholders. Citi has published a special focus report on the upcoming GO bond offering. Raise the starting gun; the race will begin soon.

Where did all the bonds go?

Long-term municipal bond issuance is shrinking. I don’t need to recite the numbers, just look at the chart above (from Sifma with data from Thomson Reuters).

Municipal tax-exempt bond issuance has been lower than 2008-levels for five years. I wrote last August:

There are many factors that are weighing on issuance, but the primary one is likely to be the higher rate environment. There are other factors like shrinking federal revenues due to sequestration and rising pension and healthcare costs for state and local governments. There has been more active pressure from rating agencies about future liabilities like pensions and a lot of uncertainty about the direction that Congress will take regarding capping the muni bond tax exemption.

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