STUMP » Articles » Puerto Rico Link Dump: World of Pain » 11 June 2017, 11:54

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Puerto Rico Link Dump: World of Pain  


11 June 2017, 11:54

I mean this in more than one way.

I’ve been having hideous pain problems for the past week, and while I can, I’m just copy/pasting links while they’re still “fresh”. I have a chronic pain condition, and it’s gotten a lot worse recently. Stuff at my other blog on pain. It’s a bit of a bore, but when I don’t blog for long periods, it’s almost always because of pain. Just so ya know.

Thanks to my linkers:

And here I go. The last time I looked at Puerto Rico was about a month ago. Stuff has happened since then.


Photographer: Christopher Gregory/Bloomberg
Puerto Rico Warns It May Grab Sales-Taxes Claimed by Bondholders

Island seeks independent agents to take over creditor dispute
Commonwealth highlights ‘acute cash management issue’
Puerto Rico will likely need to fund government operations using sales-tax revenue claimed by warring factions of bondholders unless a legal dispute at the heart of the island’s bankruptcy is resolved by November.

The federal oversight board charged with restructuring Puerto Rico’s $74 billion debt asked a judge to let the board appoint two independent agents to help litigate a dispute over who owns cash collected by the government’s sales tax agency, known by its Spanish acronym Cofina. In court papers filed Saturday morning, lawyers for the oversight board said those agents should take over the fight currently being waged between general-obligation bondholders and Cofina bondholders.

The U.S. Bankruptcy Court in San Juan will decide who has control over $400 million of funds held by the sales-tax bond trustee. If the court rules that Puerto Rico doesn’t have claim to any sales-tax revenue, then the island will face “acute cash management issues” that may require it to borrow sales-tax revenue after Nov. 1 from the island’s sales-tax agency, the commonwealth said in the court documents.
Some Cofina bond insurers have argued that Cofina needs to have an independent voice in the bankruptcy case. Bienenstock’s proposal would allow creditors to nominate as many as three potential agents for Cofina and as many as three for the commonwealth. But the oversight board would make the final decision on who to hire.

Puerto Rico is warning it may need sales-tax revenue two months earlier than usual. Sales-tax receipts begin flowing to the bond trustee on July 1, the start of its fiscal year, until January when the island’s general fund gets that money.

The commonwealth has $17.3 billion of sales-tax bonds outstanding and $17.8 billion of general obligation debt and agency bonds sold with the island’s general-obligation pledge. Those obligations account for about 55 percent of Puerto Rico’s debt.

Puerto Rico’s motion follows U.S. District Judge Laura Taylor Swain’s decision on May 30 to suspend payments to sales-tax bondholders until the parties resolve who has control of the $400 million of reserve funds.

I’m sure Puerto Rico needs all sorts of cash to cover all sorts of services for its residents.


Part of how Puerto Rico got in this mess was promising all sorts of services to its residents without the werewithal to provide such services on their own steam.

So they borrowed to fund these operating expenses.

They pretended they could keep borrowing by “pledging” various cashflows to bondholders for specifically-issued bonds… but guess what?

Hey bondholders, we need the money more.

Forget that some of those bondholders are Puerto Rican retirees themselves.

It’s sad when individuals believe governmental promises, when those promises are empty. It’s even sadder when investors who should know the political and legal risks get sucked in, too.

A few more recent stories:


Puerto Rico creditors open to mediation in bankruptcy court

Puerto Rico’s main creditors, meeting before a U.S. bankruptcy judge in the largest public finance restructuring case in history, are interested in continuing mediation settlement talks to resolve the island’s unpayable $70 billion debt bill.

In the first hearing since the U.S. commonwealth filed for bankruptcy on May 3, a lawyer for Puerto Rico’s federal financial oversight board told U.S. District Court Judge Laura Taylor Swain that the two main creditor groups expressed interest in maintaining the discussions while the case proceeds.

Swain, the soft-spoken Manhattan jurist tapped by the U.S. Supreme Court to handle the bankruptcy, said the “scope and scale” of the case is “humbling” and that it “will certainly involve pain” but that “failure is not an option.”

Oh, ffs. Failure is always a possibility. The question is how things fail.

And sometimes you don’t have much control over that either.

But I wouldn’t be feeling too good to be hearing such puffy bullshit from a bankruptcy judge.

She added, before a packed courtroom with an estimated 100 people and two additional overflow rooms, that “devoting all our time to litigation cannot” be a way forward.

That, on the other hand, is a good point. That’s the whole point of a bankruptcy process. To curtail litigation, and, again, this is not really a happy message to bondholders, but there are few happy messages to creditors in a bankruptcy, other than you’re not getting 0% back.

Doesn’t that make you feel good, bondholders?

Wednesday’s [May 17] hearing marked the start of a process that could take months or years. It is also a culmination of more than two years of bitter debate between Puerto Rico’s government, its creditors and federal lawmakers over how the island should rework its debt load that has crippled its economy.

Marcia Goldstein, a lawyer representing MBIA’s National Public Finance Guarantee unit, which insures nearly $2 billion in combined GO and COFINA debt, criticized both the government and oversight board for a lack of financial information.

“There needs to be a serious openness about financial data. We are very, very far from that,” she told Swain.

Before adjourning, Swain addressed that concern, asking for a status report by mid-June on progress to give creditors better access to financial information and any progress on restructuring negotiations.


Glad you asked.

Puerto Rico seeks court’s help to save public pension system

SAN JUAN, Puerto Rico (AP) — Puerto Rico’s governor says he’ll ask a court to restructure the debts of the U.S. territory’s public pension system, which is projected to run out of money this year.

Gov. Ricardo Rossello says the government has been unable to reach a deal with creditors to whom it owes some $3 billion.

Rossello said late Sunday that retired workers will still receive their pensions. He says the government will dip into its general fund once the pension system itself runs out of money. The pension system is underfunded by some $50 billion.

The previous administration already had trimmed benefits and a federal control board overseeing the island’s finances is seeking more cuts. It says the system will switch to pay-as-you-go funding.

Puerto Rico’s pensions are essentially pay-as-they-go.

They have no pay, as they go, so hey, perhaps pensions need to be cut drastically.

Yes, it’s ugly.

That’s what happens when you don’t pre-fund pensions. Remember Detroit? And they tried to fund their pensions.

They still got whacked.

Roads & pensions swept up in Puerto Rico’s $123bn bankruptcy

Puerto Rico’s bankruptcy process has spread to the territory’s pension system and highway authority, bringing the amount involved to over $120 billion and far exceeding the previous municipal bankruptcy record.
The Employees Retirement System (ERS) and the Highways and Transportation Authority (HTA) were added to the proceedings already involving the territory’s government and the island’s sales tax financing corporation (COFINA).

Puerto Rico and its agencies are roughly $74 billion in debt. While there are conflicting estimates about the gap between the ERS assets and promises, Puerto Rico officials estimated the pension fund’s unfunded liabilities at around $45 billion, with another $3 billion owed to bond-holders. The highway agency is another $6.3 billion in debt, $1.8 billion of which is owed to Puerto Rico’s industrial development bank which is itself insolvent.

The amounts involved are far greater than the previous record for municipal bankruptcy in the US, set by the $18 billion Chapter 9 claim by Detroit, Michigan in 2013.

Unlike Detroit, however, Puerto Rico is restructuring its debt under a special law enacted by President Barack Obama in 2016, known as PROMESA (Puerto Rico Oversight, Management, and Economic Stability Act), which appointed a special oversight board to help the island territory cope with its debt burden.

All is fair game in a bankruptcy. Pension debt is a debt. It may not get paid.


Defunct Puerto Rico Bank Resurfaces for Tax Fight

Shuttered in bankruptcy, Doral Financial lives to fight in Puerto Rico debt restructuring

A defunct Puerto Rico bank that closed its doors in 2015 over a bitter tax dispute isn’t done battling the local government yet.

Doral Financial Group, which shut down in chapter 11 two years ago, is preparing to bring claims against Puerto Rico as the U.S. territory embarks on what amounts to the largest U.S. municipal bankruptcy ever, said Brian Pfeiffer, a lawyer representing what remains of the company.

The collapse of Doral’s banking unit was the costliest U.S. bank failure since 2010, but the company’s struggles went back a decade earlier and included an accounting scandal, a failed recapitalization and a ruinous tax battle that tanked its stock, costing Wall Street shareholders hundreds of millions of dollars.

While most of Doral’s assets were sold off to repay creditors, its bankruptcy plan preserved certain tax attributes in the hope they could eventually be monetized. The remnants of Doral are now asserting the right to $296 million in Puerto Rico tax deductions, plus a roughly $34 million tax refund, Mr. Pfeiffer said.

The tax deductions, which can allow their holder to avoid paying taxes on income, could represent a valuable asset for creditors, provided Doral can find a buyer who is confident they would be honored.

Doral had long battled Puerto Rico over past tax overpayments, but the situation changed dramatically in 2014 when the local Treasury Department refused to honor a $229 million tax refund the company had negotiated under the prior gubernatorial administration.

The company hit back by hiring Washington public-relations firm DCI Group to mount a campaign to pressure former Gov. Alejandro Garcia Padilla to pay up, foreshadowing the intense lobbying campaign in Congress last year over the terms of Puerto Rico’s federal rescue package. Doral ran out of time and money when a Puerto Rico court nixed the refund in February 2015, and days later federal regulators shut down the bank.

Doral’s investors suffered repeated setbacks in the 2000s amid turmoil at the company and a downturn in Puerto Rico’s economy. Improper accounting forced the company to restate earnings in 2006 with a 56% cut to profits, and a recapitalization the following year failed to stabilize its balance sheet. The local legislature also launched an investigation into Doral’s hiring of Puerto Rico’s former Treasury Secretary months after the tax refund was negotiated in 2012.
The U.S. government’s bankruptcy watchdog said Friday [May 19] it would appoint a committee of unsecured creditors in Puerto Rico’s restructuring proceeding, and Doral wants a seat at the table to advocate for “fair treatment” of tax claimants, Mr. Pfeiffer said.

Isn’t it funny what pops up when there’s money to be had?



Oh, this is fun.

Detroit and Puerto Rico: Which Is the Worse Insolvency?

Over four decades beginning in the 1970s, the U.S. financial system had one big municipal debt crisis per decade. These were New York City in the 1970s, the Washington Public Power Supply System (“Whoops!”) in the 1980s, Orange County, California in the 1990s, and Jefferson County, Alabama in the 2000s.

But our current decade, not yet over, has already set two consecutive all-time records for the largest municipal insolvencies in history: first the City of Detroit, which entered bankruptcy in 2013, and then Puerto Rico, which is now in an equivalent of bankruptcy especially created for it by Congress (under Title III of the PROMESA Act of 2016).

Between bonds, unfunded pensions, and other claims, Detroit’s record-setting debt upon bankruptcy was $18.8 billion. Puerto Rico has far surpassed that. Its comparable debt is $122 billion, or 6.5 times that of Detroit, with $74 billion in bonds and $48 billion in unfunded pensions.

On the other hand, Puerto Rico is five times bigger than Detroit, with a population of 3.4 million, compared to 687,000. We need to look at the problems on a per capita basis.

The result is not optimistic for the creditors of Puerto Rico. As shown below, Puerto Rico’s debt per capita is much bigger—33% higher— than Detroit’s was in 2013: about $35,800 versus $26,900.

On top of more debt, Puerto Rico has much less income per capita—23% less—than Detroit did. So as it arrives in court for a reorganization of its debts, its ratio of debt per capita to income per capita is 3.1 times, compared to 1.8 times for Detroit. As shown below, this is 70% greater relative debt—or alternately stated, Puerto Rico’s per capita income to debt ratio is only 59% of Detroit’s.
As a macro estimate, if we take as a baseline Detroit’s average settlement of 53 cents on the dollar and multiply it by Puerto Rico’s 59% of Detroit’s ratio of per capita income to debt, we get a guess of 31 cents on average for all the creditors. This is not extremely different from the official fiscal plan approved by the Puerto Rico Oversight Board, which estimates cash available for debt service of about 24% of the contractual debt service over the next ten years.

I’m not actually all that interested in saying which of these is worse.

I imagine Puerto Rican retirees are going to get hit harder than Detroit retirees, mainly because they have an assetless pension fund.

Will Puerto Rico Find A Way To Survive Its Debt Crisis?

Puerto Rico is battling its way through the most severe economic crisis in its modern history. The island’s crushing debt load, which includes $123 billion in bonds and unfunded pension liabilities, is expected to top 107% of GDP by 2018. Puerto Rico is home to only 3.5 million people. Its debt load is worth $34,000 per person. The challenge is Puerto Rico’s economy is languishing and the island has few options for generating the tax revenue needed to pay its debt payments. On May 3 Puerto Rico entered into a process similar to bankruptcy to try and resolve its debt crisis in a New York court. On May 31 Puerto Rico’s governor announced a budget plan that would cut government payroll expenses by 13%, assume responsibility for pension payments, and allocate just $800 million to debt service.

Republican politicians such as Paul Ryan and Trump have been adamant that the federal government will not offer Puerto Rico any sort of taxpayer-funded bailout. Now a judge will help decide how much Puerto Rico can actually pay and how much bondholders will have to write off as Puerto Rico works to restructure and move forward. If bondholders push for draconian austerity measures and squeeze the lift out of Puerto Rico’s already fragile economy Puerto Rico will be back in court again soon asking for more debt relief. If creditors try to squeeze Puerto Rico too hard many young workers will simply opt out and move to the U.S. mainland to look for work.

To get a sense of what investors can expect from Puerto Rico moving forward I reached out to Gibran Cruz Martinez, a political economist at the University of Agder and expert on Puerto Rico’s economy.

Nathaniel Parish Flannery: What’s behind this crisis? How did Puerto Rico’s economy slip into this mess in the first place?

Gibran Cruz Martinez: Among the multiple factors that have contributed to the actual economic, fiscal and debt crisis are a collapsed economic development model, the misuse and overuse of debt issuance, and a limited and inefficient tax revenue collection system. Over the last seventeen years, the government of Puerto Rico managed to triple its public debt from $24 billion to $74 billion. In addition to that, civil servants’ pension scheme adds an additional $49 billion in debt.

One of the biggest problems is that Puerto Rico’s longtime “industrialization by invitation” model was based on the attraction of U.S. capital by creating a kind of tax haven with multiple federal and national tax exemptions. Following orthodox economic paradigms and trickle-down theory, the government was aiming for economic growth, employment creation and capital formation based on an export-led-growth model fueled by foreign capital. In 2006 section 936 of the U.S. tax code was eliminated, the tax incentive disappeared, U.S. firms stopped being able to relocate the income generated by subsidiaries in Puerto Rico as tax-free dividends, and the entire model collapsed. Since then, the economy has shrunk by 9.4%, the number of employed persons has been reduced by 21%, manufacturing employment fell by 38%, gross capital formation has been reduced by 57%. Thing are so bad right now that the latest 2017 Economic Activity Index is at May 1992 level!

With the economic development model broken debt issuance became the easiest solution to cover the structural gap between revenues and expenses and to refinance old debt. Now Puerto Rico is facing crushing debt obligation and is restricted by severe limitations on its ability to raise revenue.

One of the biggest problems is the government’s low capacity to collect taxes. Excessive tax exemptions and preferential contributory rates have further impaired the government’s financial health. Puerto Rico has a small labor force contributing to public revenues via direct taxation. It’s just 40.5% of the population paying income taxes. Total, individual income tax revenue represents 1.9% of Puerto Rico’s GDP. The OECD average is 5.8%. Corporate tax revenue accounts for 1.6% of the GDP. The OECD average is 2.6%.

Puerto Rico faces a real problem here. Efforts to attract investment by slashing taxes diminish the island’s ability to raise revenue. In an attempt to increase competitiveness and attract investors the corporate tax rates has been reduced to 4%, with the possibility of 100% tax exemptions on dividends, property taxes and capital. Restrictions on tax revenue have produced unbalanced budgets throughout the last few decades.

Parish Flannery: What steps has Puerto Rico’s government already taken to address the debt crisis?

Cruz Martinez: The first measure taken in June 2015 was to acknowledge Puerto Rico’s incapacity to meet the official debt service requirements. Puerto Rico has to make around $5.3 billion in average annual debt service payments during the next decade a figure that represents 59% of the 2017 fiscal year budget and 7.6% of the 2016 GDP. Puerto Rico’s economy has actually contracted by around 1.5% a year over the last decade. I think that right now the archipelago is incapable of meeting the debt repayment obligations without depriving its residents of essential services.

Right now the government’s strategy to address the debt crisis in the new Fiscal Plan is increasing revenue via taxes and reducing expenditure via austerity measures.

Among the multiple austerity measures, the government has decided to freeze payroll increases for fiscal years 2018 to 2020, eliminate holidays and sick day liquidations, reduce general fund subsidies to the University of Puerto Rico by $512 million, a cut that represents a 59% reduction. Other steps include implementing a new healthcare model in which the Government only pays for essential services, reducing pension benefits by 10% starting in 2020, and taking steps to further liberalize the private and public labor market. The Government is also shutting down 179 public schools. Taking into account the 150 schools closed in the 2010-2015 period, Puerto Rican children now have around a quarter fewer schools to attend.

In addition to cuts to spending we also have efforts to boost tax collection. The new revenue sources consist of a new corporate tax policy with fewer exemptions, a new internet sales tax, an increase in excise taxes, a new property tax, and an increase in traffic fines. These changes are in addition to previous hikes such as a 64% increase in the sales tax rate and various tax hikes on gasoline.

In summary, the main opposition party (Popular Democratic Party) recently argued that the current government created 84 new taxes during the first two months of 2017. If we add to this the alleged 90 new taxes implemented by the former administration, the basic arithmetic operation results in 174 new taxes for the residents of the Caribbean archipelago. I think these regressive taxes place a real squeeze on residents and might increase incentives for some people to move to the U.S. mainland.

Parish Flannery: How do you expect to see the bankruptcy process unfold? Do you think there’s a conflict between maximizing payouts to creditors and catalyzing sustainable economic development?

Cruz Martinez: When the U.S. federal law PROMESA was enacted on June 30 2016, it protected Puerto Rico’s government with an automatic stay provision. However, Puerto Rico’s government and the U.S. imposed Financial Control Board failed to renegotiate and restructure most of the debt via the out-of-court process instrumentality, PROMESA’s Title IV provision. So, right now we are seeing the Financial Control Board resort to Title III of PROMESA. This is a form of bankruptcy, a court-supervised process, used by the unelected “Junta” as a last resort to restructuring the debt.

The bankruptcy process shares some similarities with Detroit’s bankruptcy in 2013. In both cases, an unelected authority failed to negotiate “a haircut” with bondholders, were sued by creditors and declared bankruptcy. Both cases exhibit different types of debt and a similar set of creditors. Given the size and complexity of the debt, the process in Puerto Rico should take more than Detroit’s exceptionally fast 17 months.

The bankruptcy hearings kicked off in mid May. U.S. District Judge Laura Taylor Swain is going to be responsible for the decisions to restructure at least $120 billion of Puerto Rico’s debt and pension obligations, and will work to reconcile disputes among bondholders. In effect, she will make the decision of how much the people of Puerto Rico will have to sacrifice in order to resolve this debt crisis.

Rather than maximizing payouts to benefit creditors, Judge Taylor should soon realize that some current creditors are not the original bondholders. On the contrary, hedge funds, including so-called vulture funds, own more than 50% of the debt. This is debt they bought with significant discounts in secondary markets in order to try and squeeze out a profit.

Both the population and creditors will end up eating some costs. I think we have to acknowledge the fact that bondholders knew the risk they were taking while purchasing a junk bond. With that in mind I really think creditors need to assume the consequences and cannot expect to ruin a country for generations to come in order to recover 100% of the investment.

I don’t have a huge amount of pity for institutional investors snapping up Puerto Rican bonds.

But many of those bondholders are Puerto Ricans themselves.

Perhaps general retail investors should not be allowed to invest in junk bonds, eh? In their retirement accounts, at least?

In U.S. laws, we allow people to be complete dumbasses with their own money.

But maybe there shouldn’t be a tax incentive to do these dumbass things. Just a thought.

Of course, bankrupt governments are not interested in admitting their own bonds are junk, so that kind of makes it difficult to put in such policies, but it is something to think about. The reason individuals invest in municipal bonds – and no, it’s not just “the rich” – is that no taxes are paid on the interest, depending on the tax regime, etc. Higher yield was an extra enticement, too.


Assured Guaranty Files Adversary Complaint Challenging the Commonwealth of Puerto Rico’s Illegal Diversion of Special Revenue Bond Collateral

HAMILTON, Bermuda—(BUSINESS WIRE)—Assured Guaranty Ltd. (NYSE:AGO) (together with its subsidiaries, Assured Guaranty) released the following comments regarding the adversary complaint filed today challenging the Commonwealth of Puerto Rico’s illegal diversion of special revenue bond collateral that secures the payment of bonds (PRHTA Bonds) issued by the Puerto Rico Highways and Transportation Authority (PRHTA).

Two Assured Guaranty bond insurance subsidiaries, Assured Guaranty Municipal Corp. and Assured Guaranty Corp., filed an adversary complaint in Federal District Court in Puerto Rico today seeking (i) a judgment declaring that the application of pledged special revenues to the payment of the PRHTA Bonds is not subject to the Title III automatic stay and that the Commonwealth has violated the special revenue protections provided to the PRHTA Bonds under the Bankruptcy Code; (ii) an injunction enjoining the Commonwealth from taking or causing to be taken any action that would further violate the special revenue protections provided to the PRHTA Bonds under the Bankruptcy Code; and (iii) an injunction ordering the Commonwealth to remit the pledged special revenues securing the PRHTA Bonds in accordance with the terms of the special revenue provisions set forth in the Bankruptcy Code.

With this action, Assured Guaranty seeks to halt the latest in a series of unconstitutional and unlawful acts undertaken by the Commonwealth (and endorsed by the Financial Oversight and Management Board for Puerto Rico) to manage its financial distress. Since November 2015, the Commonwealth has engaged in an ongoing scheme of constitutional and statutory violations, which repudiate the rule of law by diverting special revenue bond collateral from the payment of PRHTA Bonds to other, unauthorized uses. This illegal diversion of special revenue bond collateral not only impairs Assured Guaranty’s contractual rights and takes its property interests, but also violates the special revenue protections of the Bankruptcy Code, which Congress incorporated into Title III of the Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA). These protections guarantee that holders of special revenue bonds, or their insurers, receive the benefit of their bargain by protecting the lien on post-petition special revenues and exempting the application of such revenues from the automatic stay. Finally, this illegal diversion of special revenue bond collateral should prevent the Commonwealth from accomplishing a primary objective of PROMESA, which is the ability to return to the capital markets.

Irrespective of the Commonwealth’s and Oversight Board’s flagrant repudiation of constitutional and statutory protections provided to the PRHTA Bonds and their unlawful expropriation of special revenue bond collateral, payments to holders of PRHTA Bonds insured by Assured Guaranty will continue to be paid without interruption for the life of the bonds. Assured Guaranty unconditionally and irrevocably guarantees full and timely payment of scheduled debt service, in accordance with the terms of Assured Guaranty’s insurance policies, and upon payment, takes over the rights of the insured bondholders. Assured Guaranty is determined to take reasonable and necessary actions to protect its rights as insurer of PRHTA Bonds.

The above is a press release from a bond insurer, dated 3 June 2017.


4 reasons why Puerto Rico’s ‘bankruptcy’ process matters to US residents – no, I’m not going to grab all 4. Just follow the link to read the whole thing.

I will pull only the first item for now:

A default would have far reaching impacts across the U.S. bond markets

Some of the investment companies that have a significant stake in Puerto Rico could perhaps collapse if they are not repaid, and potentially trigger a situation like last decade’s subprime mortgage crisis. Consequently, the companies with the highest levels of exposure to risk are expected to litigate vigorously.

One of these companies is Ambac Assurance, which insures up to $11 billion in Puerto Rican bonds and owns approximately $268 million in island bonds. Ambac filed a motion on May 17 opposing Judge Swain’s decision to consolidate for administrative purposes the Title III requests filed by the Oversight Board, arguing that any consolidation will reduce their chances for recovery. On June 1st, District Judge Laura Taylor Swain granted a motion filed by Puerto Rico’s Oversight Board and issued an order stating that these cases would be consolidated for procedural purposes only.

Now, who are the big players in municipal bonds? I know of two, specifically: individuals seeking tax-free returns (often retirees) – but these are not often the buyers of bond insurance; the other are insurance companies.

To not impinge on my day job (because I took a look at how much insurers were involved in Puerto Rico), here is a report from the NAIC, a regulator group, on insurer investment in munis:

[10 February 2017] Municipal Bonds in U.S. Insurer Portfolios, Year-End 2015

Municipal bonds are an integral part of the U.S. insurance industry’s investments, and with historically low default rates, they can provide portfolio diversification through high-quality investments. U.S. insurer holdings of municipal bonds have increased annually at least since 2011, to a book/adjusted carrying value (BACV) of $556 billion at year-end 2015 from $467 billion at year-end 2011. This translates into a combined increase of $89 billion or an aggregate change of 19%.
….. Largest State Exposures

For year-end 2015, municipal bonds issued by Texas and its subdivisions comprised the largest single-state holding for insurers, or 10% of all reported municipal bonds, with BACV of nearly $58 billion. Municipal bonds issued by California and New York also accounted for a large portion of the total, at 9% and 7% each, respectively. Table 6 identifies the top 10 states’ exposures by statement type and as a percentage of total municipal bond exposure for the overall U.S. insurance industry. As the table shows, the top 10 states accounted for half of the industry’s overall municipal bond exposure at year-end 2015. The same 10 states also comprised the bulk, or 48%, of U.S. insurer municipal bond exposure at year-end 2014.

Table 6: Ten Largest State Exposures as of Year-End 2015, BACV, $ Mil.

Puerto Rico’s current ratings (Caa3/D/D), however, represent an in-or-near-default status (NAIC 5/NAIC 6 designation equivalents) due to the commonwealth’s payment default on certain GO bonds in July 2016. Moody’s currently has a developing outlook, which it assigned in July 2016 after the U.S. Senate passed a measure (the Puerto Rico Oversight, Management, and Economic Stability Act, or PROMESA) to create an Oversight Board to oversee Puerto Rico’s fiscal reforms and debt restructuring. Moody’s believes that the measure “may improve aggregate investor recoveries by providing for an efficient resolution of Puerto Rico’s crisis and taking steps to halt the decline of its economic base.” U.S. insurers had a relatively small exposure ($1 billion in BACV and approximately $4 billion par value) at year-end 2015; Puerto Rico’s current outstanding debt, most of which is in municipal bonds, is about $72 billion.

So, with respect to insurers, they don’t actually hold a lot of Puerto Rican bonds. But check out that table of exposures.

If you read the whole thing, you will see that it’s mainly property/casualty insurers (think: auto and home insurance) with the highest exposures. There are reasons for the differences but the main one, taxes, covers what you need to know.

The reason insurers don’t necessarily lard up on high-yielding munis like Puerto Rico is that the more risk they lard on in assets, the more they’re required to hold in capital. It’s a balancing game.

and that’s enough encroaching on my day job.

In any case, there needs to be more discipline to the muni market. It’s ugly if the specific “bankruptcy remote” structures are broken down in a Puerto Rico bankruptcy, because those holding similar bonds in places like Chicago or Illinois may be feeling queasy.

And maybe they should.


Puerto Rico Utility Deal Shows Signs of Unraveling

Federal oversight officials break with Republican leadership on debt strategy

Wall Street investors battling Puerto Rico for payments had viewed the U.S. government’s intervention as helping their cause. Now they fear the opposite may be true.

A $9 billion restructuring deal covering the island territory’s electric utility debt is at risk of collapsing as U.S. officials supervising Puerto Rico’s finances struggle to reach consensus on the merits of the agreement, according to people close to the matter. The financial settlement has lost support in recent weeks among the seven voting members of Puerto Rico’s federal oversight board, leaving the viability of the deal in flux and creditors dubious about its fate, these people said. The fluid situation has opened up tensions between the oversight board and certain Republican leaders in Washington.

Creditors were instrumental in convincing Congress to install the oversight board last year, saying an impartial financial management entity was needed to rehabilitate Puerto Rico’s finances and facilitate voluntary agreements to renegotiate its debts.

Bondholders under the existing deal would receive new debt worth 85% of their claims, paid from a new charge on utility customers. But the oversight board’s delay in deciding on the proposed terms has rattled investors who hoped the deal would set the tone for consensual settlements of Puerto Rico’s other debts. Without a settlement framework in place, the power monopoly known as Prepa could join in the territorial government’s court-supervised bankruptcy, where a judge would decide who gets paid what.

Unrest has been growing for years in Puerto Rico over an unreliable energy service that costs consumers more than in every U.S. state but Hawaii. A massive blackout last year left Prepa customers without power for three days. Also last year, the Santa Rosa Hospital in the coastal town of Guayama had its power cut off after failing to pay millions of dollars in utility bills. A court later ordered the power back on.

Investors now view the oversight board as a drag on debt recoveries, if bond prices are any indication. Benchmark Puerto Rico general obligation bonds have tumbled to 60 cents on the dollar, down 17% since March. The 10-year fiscal plan approved that month rejected some of Gov. Rosselló’s deepest austerity suggestions and replaced earlier growth estimates with more conservative figures, lowering debt payments to $787 million annually from $1.2 billion and leaving less money to broker settlements. The board also nixed negotiations with general obligation bondholders shortly before Puerto Rico entered what amounts to the largest ever U.S. municipal bankruptcy.

“What a lot of smart people told us a year ago would solve Puerto Rico’s problems hasn’t worked out,” Iowa Sen. Chuck Grassley, a Republican, said in a May 24 floor speech.

It remains unclear how the oversight board’s approach could affect Gov. Rosselló’s efforts to sway congressional Republicans and Trump administration officials to bolster Puerto Rico’s share of federal health-care subsidies and accept its bid for U.S. statehood.

On Sunday, Puerto Rico will hold a plebiscite on its political status orchestrated by the pro-statehood Rosselló administration. Voters will choose between seeking U.S. statehood, maintaining the current territorial status or political independence, in which the island would adopt a status recognizing its sovereignty.

The local government continues to support Prepa’s restructuring agreement, said Gerardo Portela, executive director of Puerto Rico’s Fiscal Agency and Financial Advisory Authority, known as AAFAF. The oversight board chairman, José Carrión III, said it was “expecting additional information shortly” before taking a position.

There are various people, oh, say in hedge funds, who assume they can use their connections and/or expertise to get gains out of a situation that someone without said connections or expertise would not be able to reap.

I don’t think this is nefarious, per se. Some of the original finances of the U.S. were founded on specualtors who bought up scrip and otherwise-worthless bonds from individuals, because these people did not need ready cash (and yes, some were well-connected). This is the sort of thing on which Alexander Hamilton built his reputation, though he did not make money out of it himself.

But the point is there’s risk.

And when you’ve got an actual bankrupt entity, you may not actually get the cash you cleverly calculated on.

If there’s too much of this sort of thing, then bondholders in other bankruptcies find there’s no vulture hedge fund folks to help them get some better-than-nominal amount back on their principal investment.

This is ugly.

This is painful.

But in the case of an entity like Puerto Rico, it’s unavoidable. They were balance sheet bankrupt a very long time ago, and they’re finally up against the wall. Individuals tend to get taken to bankruptcy court well before the extreme cash flow bankruptcy we’re seeing with Puerto Rico.

Bankrupt governments can coast for quite a while before the crash comes.

And when they do finally crash, it’s pain all around.

The lesson here is that government’s shouldn’t engage in the behaviors that cause this inevitable conclustion to begin with; the issue is that the cause-effect loop is very extenuated in time.

Many of the politicians who fed this problem are long dead. They’re not going to be feeling any pain, except possibly with respect to their reputations. But what is reputation to a dead person?

It would be nice to think of those people in the eighth bolge of the eighth circle of Hell, but being a Christian, I do believe they could have repented. They may merely be in the fifth terrace of purgatory. May these souls get mercy, and not what they, and all of us, merit.

But such eventual salvation will not do much for the material well-being for those who will suffer the result of such bad counsel and action.

ADDITIONAL: A symbolic vote for Puerto Rican statehood garners over 90% statehood approval and 23% participation.

This doesn’t do much about anything.

Compilation of Puerto Rico posts

The State of the States: a Compilation

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