Puerto Rico Government Development Bank’s clogged balance sheet

The Puerto Rico Government Development Bank (GDB) has indicated that it could sell up to $2 billion of bonds this year to refinance loans it made to the Puerto Rico Highway and Transportation Authority (PRHTA). These loans on the GDB balance sheet comprise about 24 percent of the GDB’s assets. The PRHTA is a money-losing operation with $4.7 billion of its own debt outstanding. If the GDB is successful in moving these loans off its balance sheet, then the PRHTA could be carrying up to $6.7 billion in debt on a very shaky revenue base.

If you think that you might be interested in participating in a PRHTA bond offering, you really should first talk to Alan Schankel, Managing Director of the Fixed Income Strategy team at Janney Montgomery. He has written an excellent report that looks at the Highway and Transportation Authority. Here are some key takeaways from his report [my comments in brackets]:

    The toll and tax revenue streams securing Highway and Transportation Authority bonds have been pressured by the island’s stagnant economy. [Note that year over year revenues are down] A gross receipts pledge and monthly deposit mechanism represent a strong security framework from bondholders’ perspective, but operating expenses and losses must also be considered in evaluating creditworthiness. [Operating expenses far outstrip revenues after debt service]

    GDB has extended more than $2 billion of short term loans to the authority. The plan is to issue bonds to finance repayment. [In other words, moving the bad loans off their books] Significant revenue increases are needed if the authority is to remain solvent and retain investment grade ratings. [It looks as if revenues would need to increase at least 50 percent to cover operating losses and service additional debt] A series of management stumbles, not typically seen with a $5 billion bond issuer, heighten concerns. [Go on…] It remains to be seen if the political will exists in Puerto Rico to take measures needed to dig PRHTA out of the fiscal hole in which it finds itself. [The political beast rules muniland]

In the breakdown from the PRHTA (page 15), you can see how all revenue streams have fallen over the last five years:

Toll revenue fell from 2011 to 2012 since Puerto Rico sold off two of its toll roads to Goldman Sachs and Albertis in 2011. And there was a kerfuffle in early May over the fear that the PRHTA might miss its July 1 bond payment, which the GDB president batted down.

Generally when bond markets lend more to operating entities with declining revenues and growing debt burdens, buyers want higher yields. Puerto Rico general obligation bonds due  2023 are now trading at 5.23 percent. It’s likely that investors would want higher rates since highway debt will have lower seniority. Although the yields will be very high, if you have an appetite for these bonds, call Alan Schankel first. I’m sure that he can walk you through their strengths and weaknesses.

Official says Gensler asked not to be renominated

The media has been increasingly focused on a replacement for Commodities Future Trading Commission chairman Gary Gensler, whose term expired April of 2012. While up until several months ago the White House had made public its desire to renominate him for chairman, there has never been confirmation from Gensler whether he wanted to retain his post or step down. After I posted a piece encouraging President Obama to renominate Gensler I was contacted by a CFTC official who said that Chairman Gensler definitively did not want to be renominated. This appears to be the first public statement about Chairman Gensler’s intentions.

The clearest statement that Chairman Gensler has made previously was in a March 5, 2013 Wall Street Journal article:

Mr. Gensler said in an interview that he plans to keep working on rules to regulate derivatives trading and hasn’t decided whether he will stay at the agency for a second term.

Obama should not chase CFTC-head Gary Gensler away

The Huffington Post’s Shahien Nasiripour brought news of the Obama Administration’s effort to run off the most effective financial regulator since Franklin Roosevelt signed the 1933 and 1934 Securities Acts into law:

President Barack Obama is poised to nominate Amanda Renteria, a former Senate staffer, to replace Gary Gensler atop the main U.S. derivatives regulator amid an intensifying fight between Gensler and the world’s major banks and regulators over cross-border transactions.

And why is Gensler being run off? Nasiripour writes:

Renteria’s elevation would end Gensler’s tenure as the nation’s top derivatives overseer. A former Goldman Sachs executive who was viewed skeptically by some liberal lawmakers when he was first nominated in 2009, Gensler has become perhaps Wall Street’s leading foe as he has sought to curb risk and expand transparency and competition in the previously opaque market for a type of derivatives known as swaps.

Big muniland haircuts

Are muniland bondholder haircuts a growing trend? Actually, recoveries (the principal and interest that the bondholders recover in a default) have varied a lot, according to a Moody’s municipal default report published in May:

Recovery rates are high but variable. Historical ultimate recovery rates on Moody’s rated defaulted US municipal bonds are generally higher than those for unsecured corporate bonds. On average, the ultimate recovery for municipal bonds was about 60 percent for the period 1970-2012, compared to 49 percent ultimate recovery rate for corporate senior unsecured bonds over 1987-2012. However, municipal recovery rates for the relatively small subset of defaulted bonds are highly dispersed across individual bonds, ranging from full recovery to two cents on the dollar.

When you drill into Moody’s default data, there is only one local government bond default where the recovery was less than 100 percent – the Belfield Limited Tax General Obligation default in 1987 – where bondholders ultimately recovered 55 percent of their principal (page 14). There were also recoveries of less than 100 percent on non-general obligation bonds. The low recoveries were almost always associated with housing or hospitals projects.

The cost of defaulting on the 38 Studios bonds

The Rhode Island General Assembly’s House Finance Committee heard testimony last Thursday from Matt Fabian of Municipal Market Advisors – an independent research service with about 300 subscribers – about the cost and implications of the state defaulting on the 38 Studios moral obligation bonds. Committee Chair Helio Melo’s main line of inquiry was “Does it cost us more money in the long run” if the state were to default on those bonds?

At 29 minutes into the hearing Fabian says that it is unlikely that the state’s general obligation rating would be lowered below investment grade, but it could be knocked down one, two or three notches. He says “It could go down to a BBB, the lowest investment grade rating …  it is a scenario but not most likely.” This is the closest Fabian gets to predicting the cost.

Most members of the House Finance Committee wanted hard numbers to make a decision. Understandably, it seemed difficult for them to convert Fabian’s commentary into decisions for the state. reported:

Muniland’s balance sheet

There is always a lot of attention directed at muniland about the number of municipal securities outstanding when the Federal Reserve releases its updated Flow of Funds report (recently renamed the Financial Accounts of the United States report). This data gives a measure of how much municipal borrowing has expanded in the previous quarter. Reuters’ Lisa Lambert wrote about a small increase of outstanding muni debt and shifts in ownership patterns in the first quarter of 2013. Direct ownership of muni bonds by retail investors is declining, while institutions have increased their holdings.

More of interest to me is the macro picture for muniland’s financial assets. The Fed’s report lists the financial assets of municipalities in the same table as the financial liabilities. While muni debt has increased since 2007, financial assets, bloodied by the extra burden carried by state and local government during the Great Recession, have declined.

This decline in financial assets, when coupled with lower-funding of public pensions, paints a gloomy picture for muniland. Expect belt-tightening to continue.

Medicaid: The state budget crusher

Under the Affordable Care Act, all 50 states will have exchanges where individuals can buy healthcare insurance. But the second leg of the ACA, whether and how much to expand Medicaid, is every state’s choice. The Supreme Court gave states this right when it ruled on the Affordable Care Act last June.

The Center on Policy and Budget Priorities is mapping states’ decisions to expand their Medicaid program (as of June 4).

Many commentators presume that it is an ideological choice for governors to extend or not extend public support for the uninsured through the ACA. Pat Garofalo of US News writes:

Infrastructure land

The New York State Comptroller, Tom DeNapoli, issued a new report this month that discusses public private partnerships (P3s) and makes recommendations for municipal entities that are considering P3s for infrastructure projects. The report seems to be directed at the New York State Assembly, which had legislation that would have authorized P3s in the state without any limit on size or requirement for oversight. From the report:

Since that time, [New York] has authorized a number of agencies and public authorities to use a simple form of public-private partnership known as design-build contracting. The Thruway Authority’s procurement of the new Tappan Zee Bridge is being undertaken using design-build methods, with the expectation that this approach will streamline the project, shift some financial risk to private contractors rather than the Thruway and its users, and result in savings for the Authority.

Policy makers in New York are now considering whether to authorize more sophisticated types of P3s that depend on private financial investments. The State Fiscal Year (SFY) 2013-14 Executive Budget included a proposal for “design-build finance” P3s that would for the first time have given private firms the authority to finance public infrastructure projects.

Illinois: Driving into a ditch

The state of Illinois, which joined the union in 1818, has a state motto: “State Sovereignty, National Union.” The website Netstate says this about the motto:

Two months after Illinois entered the Union, the new Illinois General Assembly decreed, on February 19, 1819, that a permanent state seal should be obtained for use on the official documents of the state. A seal, modeled after the Great Seal of the United States, was created with some differences appropriate to Illinois as a state. Importantly, the ribbon held in the eagle’s beak was changed from E Pluribus Unum to State Sovereignty – National Union.

Now, almost 200 years later, with the state in wretched fiscal condition, chatter among municipal traders concerns the possibility of a federal bailout or a state bankruptcy for Illinois within five years. The medium-term fiscal situation is that bleak. Long-term fiscal balance is not achievable without substantial changes to the state’s pension system, which the state has struggled with since 2009. The latest effort to reform the pension system ended last Friday when no agreement was reached in the State General Assembly.

Meredith Whitney’s “Great Migration”

Since I write about muni issues every day, I couldn’t find where Meredith Whitney had covered much new ground in her book, Fate of the States: The New Geography of American Prosperity, which is released June 4. It felt like the book had been written over a year ago and was not in tune with current fiscal realities. For example, on page 117 Whitney says, “We have reached a breaking point for some states. There is no more money.” The only state that I know where that might apply is Puerto Rico. In fact, numerous states are seeing modest surpluses this year and some are rebuilding rainy day funds.

Bloomberg’s municipal columnist Joe Mysak drove straight to the heart of Whitney’s thesis:

We’re all moving to North Dakota.

Or South Dakota. Or somewhere out there in the middle of the country.

This is the thesis of Meredith Whitney’s “Fate of the States: The New Geography of American Prosperity.” The country’s “central corridor,” largely untouched by the housing bust, is going to drive the economy for decades to come.

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