Will Puerto Rico ever see economic growth?

Puerto Rico now faces a $495 million revenue shortfall for the year. Revenues have come in less than projected, and having pared government jobs under the former governor Luis Fortuño, Puerto Rico is now resorting to one-off financial maneuvers to fill the budget hole. Moody’s describes the moves in a May 15 report:

In our issuer comment of March 18, 2013, Puerto Rico Faces Large Mid-Year Budget Gap, we noted that full year revenues for fiscal 2013 were likely to be $910 million or 10.4 percent below initial estimates of $8.750 billion and 9.3 percent below fiscal 2012 revenues. Revised estimates showed the shortfall to be slightly larger at $965 million as of January 31, 2013. In response, the commonwealth has implemented a number of corrective measures, including modest expense reductions.

Puerto Rico’s revenues are likely to decline 9 percent from 2012, and it has no time to raise taxes to capture more. The commonwealth has resorted to refinancing debt and moving debt between entities. It brings to mind how shell games are played.

From the Moody’s report again:

The commonwealth also executed a number of deficit financing measures, as originally contemplated in the fiscal year 2013 budget. It executed a $333 million deficit financing via a bond anticipation note (BAN) with a private bank that it expects to take out with a future COFINA bond issue.

This is the mystery EMMA filing of April 30, 2013. The commonwealth borrowed money from a private bank and will replace it with an upcoming bond issue. It then intends to make $775 million of debt service payments with money from the PR Government Development Bank, (GDB) which will turn around and issue more debt:

Can Obamacare provide relief to distressed American cities?

A big trip line for states and cities is the host of promises they have made to provide health benefits to retirees (Other Post Employment Benefits (OPEB)). Almost universally, cities and states are shouldering these OPEB costs as they come due. Pay as you go, if you will. From a recent Bloomberg presentation:

These so-called OPEB promises made by the 15 biggest cities alone total $115 billion, with an average burden of $2,300 for every man, woman and child, according to data compiled by Bloomberg. How will local governments manage to make good on their pledges without becoming insolvent? Will we see governments reduce benefits and raise their cost for current workers, as has been the case in several cities and states?

Cities and states cannot unilaterally end these benefits, outside of Chapter 9 bankruptcy, because they are contractual promises. As Stockton, California was entering the bankruptcy process, it eliminated lifetime unlimited health care benefits for former employees and their dependents. Stockton had awarded these OPEBs to former employees who had worked for the city for as little as a month, and the expense helped push the city into bankruptcy. Retirees and former employees took Stockton to court and a judge ruled that, given the city’s fiscal distress, it could cease these benefits.

What is Governor Cuomo’s end game?

This week, New York Governor Andrew Cuomo unveiled his proposal to create a Financial Restructuring Board to help distressed local governments manage their finances. One of the key features is an alternative binding arbitration process for unions and municipalities to resolve contract issues more rapidly. New York has an unusual employee provision that leaves all previous contract terms in place if municipalities and unions fail to reach an agreement. This provision could prevent old contracts from festering with rich wage increases and swelling employee and pension costs. Governor Cuomo said in a press release:

Growing retirement costs, declining populations, decreasing property values, and the recent fiscal crisis have all contributed to the difficult financial issues facing localities today…The Financial Restructuring Board will bring together state and local officials to help localities make tough decisions and solve this crisis now instead of kicking the can down the road.

Governor Cuomo pointed his finger at four New York cities that have balanced their budgets for years with substantial state aid. It includes a chart that details state subsidies to these cities via the Aid and Incentives for Municipalities (AIM) program:

Should asset backed securities be outlawed?

On Tuesday the SEC is holding a roundtable on credit ratings to address the ongoing question of ratings shopping. Rating shopping is when a bond issuer shops its deal to various credit rating agencies to see who will assign the highest rating. The rating agencies that will assign the best ratings are given the business and the rating fee. Here is how the SEC describes its event:

As previously announced, the roundtable will consist of three panels. The first panel will discuss the potential creation of a credit rating assignment system for asset-backed securities. The second panel will discuss the effectiveness of the SEC’s current system to encourage unsolicited ratings of asset-backed securities. The third panel will discuss other alternatives to the current issuer-pay business model in which the issuer selects and pays the firm it wants to provide credit ratings for its securities.

The possibility of a credit rating assignment system comes from legislation that Minnesota’s senator Al Franken inserted in Dodd-Frank. Franken’s law requires that the SEC study the feasibility of a bureau or panel that would assign a rating agency to rate an offering. Currently issuers choose which firms will rate their offering although for structured finance or asset-backed deals issuers must share the particulars of the new deal with all raters recognized by the SEC in that category. This is equivalent disclosure and something that I have advocated with the SEC since 2007 and Congress since 2008. It has slightly increased competition in rating structured finance securities as seen in the chart above although the size of the market has declined since 2007.

Why is the US Treasury awarding a no-bid contract for municipal research?

A rather surprising notice appeared on the Federal Business Opportunities website:

The Bureau of the Public Debt, on behalf of the Office of the Comptroller of the Currency (OCC) intends to award an order to Municipal Market Advisors for Municipal Bond Research. Municipal Market Advisors is the sole provider of the Municipal Bond Research.

Did the BPD bid this award out in an open process? Well, no not exactly, in fact not at all:

More on Rhode Island’s 38 Studio bond repayments

Lots of ink has been spilled about the famous ex-Major League pitcher Curt Schilling, who convinced the state of Rhode Island’s Economic Development Corporation to issue $75 million of privately placed “special and limited obligations bonds” to fund a loan to his gaming company. After getting the loan Schilling and Company proceeded relatively quickly to go bankrupt and was unable to repay the loans to EDC, which funded the bonds.

Matt Bai, of the New York Times, wrote a lengthy story of the personalities involved but provided little detail about the financial underpinnings of the story.

Josh Barro, at Bloomberg, detailed how he badgered Rhode Island’s governor Lincoln Chaffee with questions about the 38 Studios bonds and then was offended when he didn’t get the answers he wanted. Barro unfairly blasted the governor for his pension reform, which is comparable to what 40 plus other states have done.

Australia helps retail investors buy government bonds

Australia arguably has one of the best individual retirement systems in the world. The government-sponsored system – superannuation – requires mandatory employee and employer contributions to retirement savings. In certain need-based circumstances, the government may also contribute. Australians take funding their retirements seriously, and the government is giving them a powerful new tool to save by moving trading of government bonds onto the Australian Securities Exchange (ASX). From the government:

Deputy Prime Minister Wayne Swan and Minister for Financial Services Bill Shorten today announce that Australian Government Bonds (AGBs) will be available for trading on the Australian Securities Exchange for the first time on 21 May.

Why is this important?

This will enable retail investors to buy and sell AGBs in a similar way to how they buy and sell shares. The retail trading of AGBs will make it easier for mum and dad investors, including many self-managed super funds, to hold and trade Commonwealth-backed bonds.

New Jersey is getting squeezed everywhere

The largest governor in America, New Jersey’s Chris Christie, was outed this week by the New York Post for undergoing weight reduction surgery. Reuters reports:

New Jersey Governor Chris Christie, who has struggled with obesity for much of his adult life, underwent lap band surgery in February to reduce the size of his stomach, at the urging of his wife and children, his press secretary said on Tuesday.

Harrisburg joins Jefferson County with muniland securities fraud charge

The near-bankrupt city of Harrisburg, Pennsylvania was charged this week by the Securities and Exchange Commission with securities fraud. Here is the official language (emphasis mine):

The Securities and Exchange Commission today charged the City of Harrisburg, Pa., with securities fraud for its misleading public statements when its financial condition was deteriorating and financial information available to municipal bond investors was either incomplete or outdated.

An SEC investigation found that the misleading statements were made in the city’s budget report, annual and mid-year financial statements, and a State of the City address. This marks the first time that the SEC has charged a municipality for misleading statements made outside of its securities disclosure documents. Harrisburg has agreed to settle the charges.

Bank loans and other scary things in muniland

A nine-member working group of banks, underwriters, financial analysts and attorneys released a white paper this week to provide guidance to states and municipalities on disclosure for bank borrowing – a small but significant sector of muniland. Since there is no requirement to disclose bank borrowings by public entities, no one knows what the total size of the sector is. I’ve heard numerous estimates in the $200 to $300 billion range, which would mean the sector is about 5.4 percent to 8 percent of the $3.7 trillion municipal bond market.

It’s pretty astounding that a community or a state has no legal responsibility to notify its citizens or bondholders when it takes a loan from a bank. Securities laws give authority to the Municipal Securities Rulemaking Board to only regulate municipal bond underwriters and not cities or states. Since a bank loan does not require a securities underwriter, the MSRB has no authority to compel disclosure. There is a lot of commentary trying to parse if and when a bank loan is actually a bond and hence subject to securities regulation. From Richards Kibbe & Orbe’s Brian Fraser and Paul Devlin:

The MSRB acknowledged that it is difficult to distinguish between loans and securities and pointed to the multi-factor test established by the U.S. Supreme Court in Reves v. Ernst & Young, Inc., 494 U.S. 56 (1990), which we discuss in more detail below. In essence, the MSRB warned the market in the September 2011 notice that there is no “one size fits all” solution to the questions posed by the loan/security distinction and emphasized that the analysis is dependent on the facts and circumstances of individual transactions. The MSRB issued its third and most recent notice on April 3, 2012. In that notice, the MSRB encouraged state and local governmental issuers to voluntarily post information about their bank loan financings on EMMA in order to promote market transparency and efficiency.

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