The risks of municipal default and bond insurance: Part 2

When I put up a post about bond insurance and default rates last week, I expected pushback from proponents of municipal insurance. I got some.

Events in the last seven years show anecdotal evidence for and against municipal bond insurance. The bankruptcies of Jefferson County and Detroit and the workout of Harrisburg, Pennsylvania demonstrate the value of a bond insurer that makes full interest and principal payments for defaulted bonds. Investors undoubtedly benefit from this continuity of payments.

In contrast, we have the financial collapse of 2008, when most bond insurers were downgraded below the level of the issuers they had insured. The issuers started trading on their underlying ratings, and as far as I know, they were not refunded for the insurance premiums they had paid upfront. In a big financial crisis, bond insurance is a bust.

Mark Palmer of BTIG addressed another dimension of bond insurance; the lowered borrowing cost that AA-rated bond insurers (Assured, MBIA and BAM) can pass onto the new bonds that they insure. Palmer writes:

Bond insurance prevents payment interruptions for insured investors and allows them to avoid the protracted and difficult recovery process following defaults when they do occur, which are rare for higher-rated bonds. However, the primary purchasers of bond insurance are the issuers of municipal bonds – the municipalities themselves. And municipalities gain several benefits from insurers’ wraps, including lower borrowing costs due to improved execution, capital market access – a key benefit for issuers that otherwise would have limited or no ability to float bonds without credit enhancement – and the surveillance and intervention that insurers provide.

Is muniland doping the data?

Puerto Rico and New Jersey may have played with the numbers recently to put a better gloss on their weak finances. They seem to be “doping” the data.

For example, Puerto Rico (with assistance from the Bureau of Labor Statistics) has revised six years of employment data to cast a positive upward revision to its economy. This had spillover effects on the broad economic measures of the island. From Puerto Rico’s Government Development Bank:

The payroll employment benchmark revision not only impacted the average level of payroll employment, it also changed its average growth rate for previous years.

Detroit’s wildly accelerating bankruptcy process

The technocratic governor of Michigan, Rick Snyder, and the emergency manager he appointed to restructure Detroit, Kevyn Orr, spoke at an event sponsored by the Manhattan Institute for Policy Research this week. Their relentless positivity contrasted with the creditor mess they had left behind in Detroit.

Orr insisted, as he has in other media appearances, that Detroit creditors must rapidly concede to proposed settlement terms so that the largest bankruptcy case in American history can be concluded. Bloomberg reported:

Detroit Emergency Manager Kevyn Orr said time is running out for creditors to reach an agreement with the city on a plan to resolve the biggest U.S. municipal bankruptcy by reducing $18 billion in debt.

The risk of muni default and bond insurance

Standard & Poor’s raised its ratings on two municipal bond insurers, Assured Guaranty and MBIA’s National Public Finance. Reuters reports:

Standard & Poor’s upgraded bond insurer MBIA Inc on Tuesday, saying it expects the company to gain market share and resume its prior role as a strong player in guaranteeing U.S. municipal debt.

The agency raised MBIA’s rating to A- from BBB and upgraded National Public Finance Guarantee Corp, the company’s main unit for insuring municipal bonds, to AA- from A…

Puerto Rico wants to return to the market for another $2 billion

I talked with Erin Ade of RT about Detroit and Puerto Rico. The interview starts at 3:40.

Meanwhile, on Thursday Caribbean Business reported that Puerto Rico intends to return soon to the market to borrow another $2 billion.

The government is planning a $1.5 billion deal through its Sales Tax Financing Corp (Cofina by its Spanish acronym) and a $500 million deal through its new Municipal Financing Corp (Cofim by its Spanish acronym) financing vehicle, according to Caribbean Business sources.

Is Illinois getting weaker?

Illinois has queued up contestants for the governor’s race this fall. The New York Times reports:

Bruce Rauner, a multimillionaire businessman making his first run for political office, won the Republican nomination for governor of Illinois on Tuesday, setting up what is expected to be one of the nation’s most contested races for governor this fall.

Mr. Rauner, little known to Illinois voters before an intense run of television commercials, is expected to bring a serious challenge to Gov. Pat Quinn, a Democrat seeking a second full term in office. Although control of Springfield, the capital in President Obama’s home state, has been solely in the hands of Democrats for more than a decade, a fierce contest is anticipated, in part because of the economic picture in Illinois, given the state’s poor credit ratings and high unemployment rate compared to other states.

Did Michigan kill Detroit?

After studying Detroit’s wrecked finances for several years, it was never clear if the city has been collecting the taxes it was entitled to within the law. Now a new report from the Michigan Municipal League suggests that the state gobbled up a portion of Detroit’s share of the state sales tax, adding severe stress to an already weak budget.

I wrote last year:

Detroit has no local sales tax, according to the Michigan state website. Michigan has no city, local, or county sales tax. The state sales tax rate is 6 percent.

The state collects a sales tax of 6 percent and sends it back to the city. For 2012, the state passed $172 million in sales taxes to Detroit, or 11.4 percent of general and governmental funds of $1.5 billion (page 47).

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.

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.

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