China takes another step toward municipal borrowing

Last January, when I made my predictions for 2014, I wrote:

The biggest muniland story this year will be the development of the Chinese municipal bond market. It’s not often that you get to watch a government launch a bond market. And China’s will be massive. From the South China Morning Post:

The [Chinese] mainland’s quest to solve its $3 trillion-and-growing public debt problem by starting a domestic municipal bond market hinges on the one thing officials are most afraid of: transparency.

As markets absorb the results of the latest audit of state finances, Beijing’s long-standing vow to develop a municipal bond market to curtail rapid growth in other types of hidden public debt will take centre stage once more.

Now the Chinese State Council is poised to take the next step in approving guidelines that mean local governments will be allowed to issue debt. reports:

State Council would set quota system on debt, but only under strict conditions.

China may allow local governments to sell municipal bonds under narrow parameters in a move to regulate their borrowing and reduce systemic risk.

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:

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.

A plan for Puerto Rico

Puerto Rico’s governor, Alejandro García Padilla, announced a six point plan to restructure the government in light of the credit rating downgrades by Standard & Poor’s and Moody’s.

He opened his speech that was delivered live on Monday:

In these difficult times, I want to speak personally to each citizen, whether in the living room or the balcony of their homes. I want talk about the budget of Puerto Rico, the current situation and how we face it together. It is time to pay bills that others left without paying.

The governor went on to outline six steps the government will take:

1. We will reduce the budget $170 million in current fiscal year. Much of the reduction will be in contracts with agencies. To be clear, we will succeed without employee dismissals.

EMMA is growing up

Welcome to the new, user-friendly version of EMMA, muniland’s free central repository of bond documents, event disclosures, trade data and market statistics. It’s a treasure trove of muniland’s core information and it has been redesigned to be even easier to use and more intuitive (Disclosure: I participated in several rounds of user testing as the new EMMA design was scoped).

Let’s drill down a little. The third choice on the left bar of the homepage says “Browse municipal securities information by issuer.” Click it and you will see this map:

This presents issuers by state. Choose a smaller, less populated state and click through (it will be easier to see the architecture without getting bogged down in a complex issuer like New York or California). I choose Massachusetts because it is an outstanding example of public disclosure related to the state’s debt issuance. Massachusetts’ home page looks like this (below). Documents and trade data for the entire state is aggregated.

S&P downgrades Puerto Rico: The turning of the wheel

Photo: Puerto Rico Treasury Secretary Melba Acosta (R) and Governor Alejandro Garcia Padilla at a press conference in response to S&P’s downgrade. (Source: Ustream) 

Standard & Poor’s has stepped forward as the first major rater to strip Puerto Rico of its “investment grade” imprimatur. Puerto Rico is now officially speculative-grade credit and the most widely held junk bond in muniland.

Considering the economic fundamentals, the downgrade was inevitable. Economic indicators in Puerto Rico have been plummeting with sales of cement crashing 16 percent last year and gasoline consumption dropping 5.3 percent in the same period. Bank capital in Puerto Rico has declined 4 percent year over year as the commonwealth shakes off lingering problems from the housing bust.

The shadows of muniland

There is a shadowy part of muniland. It is populated by liabilities that are absent from balance sheets and municipal debt that was contracted by circumventing the law.

Muniland’s biggest unknown liabilities are unfunded pensions and retiree health care benefits that until recently were not required to be on issuers’ balance sheets. The information related to these often enormous future expenses had previously only been reported in footnotes. Muniland’s accounting overseer said in 2012:

GASB Chairman Robert H. Attmore. ‘Among other improvements, net pension liabilities will be reported on the balance sheet, providing citizens and other users of these financial reports with a clearer picture of the size and nature of the financial obligations to current and former employees for past services rendered.’

Puerto Rico’s solvency may hang on a potentially unconstitutional corporate tax

Last June, I asked if the U.S. Treasury was bailing out Puerto Rico with an unusual interpretation of the federal tax code. This waiver or exemption allowed U.S. multinationals operating in Puerto Rico to credit taxes that were paid to Puerto Rico on their federal tax bill. The tax, referred to as Act 154, was passed by the Puerto Rico legislature in 2011. It brought in approximately $1.6 billion in 2011.

When preparing its 2014 budget, Puerto Rico had a massive $1.5 billion deficit to fill. The governor had proposed expanding the “sales and use tax” (SUT or Cofina) by 73 percent, but this was met with strong resistance from the business community. The corporate excise tax (Act 154) was raised and part of the budget deficit was filled (an $800 million deficit is still projected for the current fiscal year).

Last week an excellent explanation of the corporate excise tax was published by Martin Sullivan on The Tax Analysts Blog. Sullivan highlighted the tax’s importance at 20 percent of general fund revenues:

An index maker’s view of muniland

J.R. Rieger, Vice President of Fixed Income Indices at S&P Dow Jones Indices, hosted a webinar about the data he uses to understand muniland and the performance of munis versus corporate bonds. Here is some of his team’s analysis.

State and local tax collection data from the U.S. Census is widely used in muniland:

Below is a comparison between muniland and corporate bond defaults in 2013 (S&P Ratings data – a separate operating unit within McGraw Hill). Note the 0.107 percent default rate for investment-grade municipal bonds, 0.807 percent default rate for municipal high-yield bonds versus 2.10 percent in the S&P corporate speculative grade (high yield) index.

The many market views of Puerto Rico

“That is what makes markets” is a financial industry aphorism that means there can be a broad spectrum of views about an asset or a specific security. This is most true for the municipal bonds of Puerto Rico.

With the darkest view of Puerto Rico bonds, BlackRock’s Managing Director and Head of Municipal Bonds Group Peter Hayes told Fox Business News that the Commonwealth may have to restructure its debt “somewhere between now and the middle of 2014 when their fiscal year begins.”

In this Reuters Insider MuniLand video, Emily Raimes, Senior Credit Officer at Moody’s, outlines the fiscal and economic factors that her ratings team will be evaluating after placing Puerto Rico on negative credit watch last week.

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