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Muni Week Review / Preview 9/07/2015

Thursday, Sep 10, 2015

PUERTO RICO LAYS OUT 5-YR FISCAL ECONOMIC  PLAN. DECISIONS FOR PREPA RETAIL BONDHOLDERS. TAX HIKES ON THE WAY IN CHICAGO.

Puerto Rico Lays Out 5-Yr Plan… Like everything else Puerto Rico presents to its municipal bondholders the fiscal economic plan is vague and ambiguous. The government appointed a partisan five member working group to develop the plan, only three members participated in meetings. The two that did not participate were the Head of the Senate and Leader of the House. The plan is to reduce the island’s $72 billion public debt by restructuring $47 billion of the total debt at the expense of municipal bondholders. The plan leaves out the Electric Utility and Sewer bonds, presumably hoping Congress will eventually grant them Chapter 9 bankruptcy protection. The plan projects a best case scenario of an undisclosed $13 billion deficit over the next five years. The next five years of interest and principal payments is approximately $18 billion, which by their accounting leaves $5 billion for municipal bondholders. The group did not indicate how the $5 billion would be divided among the different classes of debt. The plan will require legislature approval and suggests a long and difficult road lies ahead. Officials in the briefing declined to reveal how they intend to treat the various types of debt or address the constitutional and legal structure of specific bond issues. Nor did they indicate any particular form such as reduced interest rates, maturity extensions or principal haircuts. It is unclear how creditors and municipal bondholders will react to the plan. “It’s our hope we can do this on a consensual basis,” said a member of the group who devised the plan. He also stated, “Chest pounding by various creditors” had begun.

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Decisions For PREPA Retail Municipal Bondholders... At this point retail municipal bondholders holding $3 billion uninsured PREPA bonds are looking at several options: (i) hold on to legacy PREPA municipal bonds paid by a more efficient PREPA (ii) exchange into new municipal bonds for 85% of par with current interest bonds with 4% to 4.75% coupon (iii) exchange for convertible capital appreciation municipal bonds with 4.5% to 5.5% coupons (iv) there could also be a cash tender offer made to retail municipal bondholders. The new municipal bonds, which stand to save PREPA $700 million over the next five years, may possibly be issued by Puerto Rico Infrastructure Finance Authority and mature in 2043. There is notable protection afforded to municipal bondholders: PREPA must transfer to a bankruptcy remote off-shore Special Purpose Vehicle the rights to collect the fees to pay municipal bondholders directly from electricity bills charged to PREPA customers.  These fees flow directly to an off-island third party, never passing through PREPA or any other Puerto Rican entity. This structure serves to isolate municipal bondholders from event risks, such as price volatility in the oil market and PREPA’s management challenges, amongst others.  The deal with forbearing municipal bondholders hinges on about 75% of non-forbearing uninsured municipal bondholders exchanging legacy bonds for new securities.

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PREPA Exchange Offer Belies Specula-tors… The agreement with forbearing municipal bondholders is a milestone.  Financial Advisor to the PREPA Municipal Bondholders Group wrote that the agreement gives PREPA a fresh start and financial flexibility. Franklin, at the forefront of the PREPA restructuring sees the agreement as a win for municipal bondholders, PREPA and Puerto Ricans. The public first learned of PREPA’s troubles in June of last year. The ensuing months saw bond prices swing to 38 cents suggesting even greater losses than 35% predicted by Moody’s. The agreement puts to rest market speculation that was costly to uninformed investors who sold at prices below 85 cents. PREPA municipal bond values rallied after the agreement. Specific structural details on the capital stack as well as electric rates will take more time. With the consensus, forbearing bondholders have kept matters out of court and hope-fully look to end the forbearance on September 18.

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Municipal Bond Insurers Demand More From PREPA… Municipal Bond insurers are demanding better terms than those accorded to forbearing bondholders. National Public Finance Guarantee is the sole municiapl bond insurer that has not extended forbearance to PREPA. With strong capital, municipal bond insurers have more options to deal with PREPA and are holding out for better terms. Because of leverage granted by bond indentures, municipal bond insurers have been deeply engaged with PREPA’s finances. Insurers get the credit for bringing to the table a greater transparency about PREPA’s value. The insurers’ focus on getting higher values lifted recovery value for the uninsured non-forbearing municipal bondholders.

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Puerto Rico GDB Talks To Investors… The GDB plans to begin confidential debt restructuring discussions with hedge funds that hold its municipal bonds. A plan under which investors would lend more money to the GDB and exchange current municipal bonds for new securities is on the radar. Avenue Capital Group, Bri-gade Capital Management and others organized this summer and hired Davis Polk & Wardwell LLP and advisory firm Ducera Partners LLC to represent their interests. GDB is paid by appropriations and is a moral obligation, the type of obligation government officials previously claimed is not a default if not paid.

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Higher Taxes On The Table in Chicago… When asked how difficult it will be to raise real-estate levies, Mayor Emanuel expressed confidence yesterday that such an increase specifically to fund public-safety workers’ pensions would pass the city council. “We’re going to do it in a fair and progressive way,” Emanuel told reporters. “If you’re asking me, do I believe we’ll get it done, the short answer is yes because I actually believe aldermen are up to the task of charting a new course for Chicago’s future.” $500 million of higher taxes to shore up police and fire-fighter pensions by $450 million and Chicago Public Schools construction program by $50 million is expected to be the centerpiece of Chicago’s spending plan due September 22. The property tax hike could be the largest tax increase in modern Chicago history. The mayor also plans to push a new garbage collection tax, a new per ride fee on taxis and ride hailing services such as Uber and a new tax on electronic cigarettes and smokeless tobacco products. Chicago is a thriving metropolis that has the ability to control its own destiny. Chicago politicians can change the direction of city finances rapidly once politics is put aside.

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With Pensions It’s All Politics… Despite efforts since the 2008 recession to rein in costs of public pension systems, pension politics creates huge obstacles to pension reform. This includes poorly informed voters, pressure from special interest groups, legal constraints and political culture. A pension expert at Manhattan Insti-tute of Policy Research praised Rhode Island, New Jersey, Utah and Virginia measures as increasing contribution rates, suspending or eliminating cost of living adjustments, forming new pension committees and even requiring convicted felons to forfeit benefits. “You need leadership willing to burn some political capital,” the pension expert cited exemplary pension reform led by Rhode Island’s Gina Raimondo.

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In Illinois Higher Taxes May Be The Answer… Pensions are the real problem, Moody’s said in a recent article on Illinois.  Retiree benefits account for 24% of general fund expenses. “The state's ability to manage these pressures will be a primary determinant of future rating actions,” Moody’s wrote, citing that the “A-” rated state has many options to address funding shortfalls. Raising the income tax, for example, could pump more than $2 billion into its coffers. Illinois is one of only eight states that levies a flat income tax, and its 3.75% individual rate is lower than the average 4.4% rate among those states, according to the ratings agency. Raising the individual rate to 4.75% and the corporate rate to 6.75% from 5.25% would generate $2.4 billion of revenue to help offset the $5 billion deficit, Moody's said. The state “could probably” impose $1.7 billion of cuts, leav-ing $500 million to be addressed by one time measures, Moody's said.

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