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Muni Week Review / Preview 8/27/2015

Thursday, Aug 27, 2015

PUERTO RICO OPPOSITION PARTY FILES LAWSUIT. PR SALES & USE TAX REVENUE UP SUBSTANTIALLY. INFLATION OUTLOOK PUSHES LOWER.

Puerto Rico Opposition Party Wants To Know The Advice Governor Is Receiving From Paid Advisors… PR House of Representative Minority Party Speaker Jennifer Gonzalez filed a law suit against the Government Development Bank and Puerto Rico government asking for release of documents showing the legal, tax and financial advice received by the ruling party from outside advisors  concerning their debt.  Separately, the opposing New Progressive Party released GDB President’s response to Franklin Advisors and Oppenheimer Funds wherein the GDB President states that non-payment of appropriation backed Public Finance Corporation municpal bonds is not a default, industry participants and rating agencies disagree.

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Puerto Rico Sales & Use Tax Revenue Up... July Sales and Use Tax collections were $40 million or 35.7% higher than the prior year. The big jump comes from many factors.The 4.5% hike in sales and Use Tax effective July 1 contributed $8 million. Several large retailers reached settlements with the government and paid back Sales and Use Taxes owed.  Market opinions are split on whether the Puerto Rico legislature would consider changing the current law and attack the COFINA municipal bond structure which is very favorable to bondholders. Any refinancing without changing current law would require the consent of both senior and subordinated bondholders. COFINA senior municipal bondholders have retained Quinn Emanuel Urquhart & Sullivan for legal counsel. Since consent is required from all municipal bondholders junior COFINA creditors are in a prime position to reject any restructuring attempt.

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Financial Control Board Needed… NYC Controller Scott Stringer joined Bronx borough President Ruben Diaz Jr. to seek transparency and accountability from Puerto Rico government through a Financial Control Board. Scott Stringer is a trustee of NY public pensions that have invested in PR municpal bonds. He spoke up against allowing Chapter 9 access to the island stating “Short of taking that dramatic step, New York City, Washington and other major cities have recovered strongly from fiscal distress through a control board mechanism rather than Chapter 9 bankruptcy.

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Dept. Of Justice Places Puerto Rico Agencies Under Funding Watch… A U.S. Department of Justice (DOJ) letter was sent to Governor Padilla advising him Puerto Rico and agencies that administer federal funds received from DOJ programs have been classified as high risk grantees. The letter, notifies the governor that after an audit, the DOJ discovered numerous findings indicating “questioned costs and significant weakness in the PRDOJ’s financial management capabilities and internal controls.” The letter refers to “serious concerns” about the administration of the funds sent to the island, adding the DOJ has decided that until the designation is changed, funds will be received as reimbursements.

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Puerto Rico Continues to Lose Credibility And Investor Confidence… On April 28th 2015 during a speech to a joint session of the island’s legislature Governor Padilla stated; “sometimes we talk about the possibility of not paying our debts…this is folly”. Then unexpectedly two months later on June 28th he announced in the New York Times the islands debt is not payable. His announcement shocked the market and many members of the Puerto Rico legislature. Prices of Puerto Rico municipal bonds tumbled.The Government Development Bank followed suit and said the island can barely fund daily operations.  In order to eliminate a $740 million 2015 budget deficit the legislature took steps. In July they approved a $9.8 billion balanced budget which included $674 million in spending cuts and General Obligation debt service.They previously approved a 4.5% increase in the Sales and Use Tax which pay COFINA municipal bonds and instituted a 4% port tax effective October 1st.The two actions expect  to create over $1 billion in additional annual revenue.They also enacted an oil tax that took effect March 1st, created to pay debt service on a $2.9 billion municipal bond issue which never came to market. The revenue from the oil tax has yet to be reassigned or if it has disclosure has not been made public. The legislature seems to have taken more than adequate steps to eliminate the 2015 deficit.  On July 1st and August 1st the supposedly broke island paid over $2.5 billion of debt service. However, on August 3rd Puerto Rico defaulted on $58 million of Public Finance Corp debt, government officials said it was not a default because it is appropriation debt and the money was not appropriated.  Since July 2014 island officials have been negotiating with municipal bondholders to restructure the electric utility (PREPA) municipal bond debt. After 6 extensions and several proposals frustrated creditors have made September 1st a deadline for the parties to reach a settlement or go to court.  Last week as arrogant as this may sound the Puerto Rico Aqueduct and Sewer Authority (PRASA) tried to sell $750 million of new municipal bonds.They seem to have ignored investor concerns that the Commonwealth defaulted on a Moral Obligation bond, has not reached a restructuring agreement on PREPA municipal bond debt and is appealing to the Supreme Court to overturn lower court rulings to reinstate their Recovery Act that allows select bankruptcies. The Recovery Act had already been turned down by a Federal Court in Puerto Rico and a Boston Court of Appeals as unconstitutional. The Puerto Rico government continues seemingly futile pleads to Congress to grant Chapter 9 bankruptcy protection. The island’s politicians realize that without Chapter 9 they will lose leverage in any debt negotiation and will be at the mercy of municipal bondholders. Creditors will petition the court to uphold bond indentures and direct dedicated revenue streams to pay debt service. The Commonwealth should soon realize it cannot ignore U.S. contract law. Oppenheimer Funds, Franklin Advisors, Goldman Sachs and numerous hedge funds along with bond  insurers are not convinced Puerto Rico cannot afford to pay the vast majority if not all of its debt.  In recent months Puerto Rico Politicians seem to be preparing for 2016 elections and appear to be playing to the populace. Despite the frivolous rhetoric of the islands politicians the clock is ticking. Municiapl bondholders who hold General Obligation and Dedicated Revenue municipal bonds with adequate to good debt coverage expect to be paid Jan 1 and Feb 1, 2016.

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Inflation Pushes Lower… Inflation expectations pushed towards the lowest since 2010 amid a drop in oil prices and a global slow down.  Minutes from the Federal Reserve’s July meeting showed that officials wanted more signs that inflation is headed toward their target. FOMC voting member Narayan Kocherlakota called out in WSJ August 19th  that current low inflation outlook does not justify a rate hike. Concerns abound that with inflation so low, higher rates could push the economy further away from the Fed’s price and employment goals. Investors have sharply marked down the probability of a September increase in the Fed’s target for the federal funds rate. They now see only a 22 percent chance that the Fed will raise its zero to 0.25 percent target at the central banks’s gathering on September 16  and 17, down from 48 percent at the start of last week. “We move our call for the first rate  hike from September 2015 to March 2016,” Michael Gapen, chief U.S. Economist at Barclays Capital Inc. In New York and his colleague Rob Martin, wrote in a note to clients.

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High Yield In New Jersey… The New Jersey Economic Develop-ment Authority sold $2.2 billion of municipal bonds in the states’s biggest debt sale since 2013. Proceeds for the issue will fund school construction costs, refinance debt and terminate derivative contracts.  The bonds are rated by Moody’s “A3”  S&P “A-”. Yields ranged over 3% for municipal bonds maturing in 2019 to over 5% for bonds maturing in 2041.The issue was oversubscribed.

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Information obtained from sources deemed reliable; GMS does not purport Review/Preview contains all available information.

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