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Muni Week Review / Preview 10/12/2015

Wednesday, Oct 14, 2015

IMF CUTS GLOBAL GROWTH. MUNIS DRAW INVESTORS. PREPA MAY OFFER HIGHER ELECTRIC RATES AND PRIVATIZATION.

Global Growth Cut Lower… The International Monetary Fund (IMF) cut its projections for global growth to 3.1% this year from 3.3% earlier; 2016 projections were also cut by the same amount to 3.6%. The grim outlook weighs on the trade gap which was sharply wider in August as foreigners sought fewer U.S. made goods. China’s deceleration and the plummet in commodity prices over the past year have revealed a developing world that over-invested with excessive leverage. Fears surrounding credit fueled bubbles in emerging markets that could pop and energy prices are behind the shift to a lower gear. Most market participants expect a Fed rate increase no sooner than December and the pace to be slow.

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Municipal Bonds Draw Investors… Individual investors poured over $700 million into municipals last week as bond yields fell to the lowest levels in five months. The longest dated debt fared the best, capturing $685 million of the cash. Benchmark 10-year municipal bond yield 2.09%. To date this year state and local debt has returned 1.9%, better than 1.6% for treasuries and 0.1% for corporate bonds. High yield municipals bonds have returned 2.9% through September.

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High Yield Municipals Outperform… Heading for their best month since August 2014 and aided by Puerto Rico bond price increases, the riskiest local government municipal bonds returned 2.9% through September, while high-yield corporate municipal bonds have lost 2.7 percent this month. In the current low-rate environment, there’s demand for incremental yield. So far this year, longer dated bonds and the “BBB-”rated sector have given investors the best overall performance.

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Fewer Infrastructure Bonds… At the smallest pace in a decade, highway, airport and mass-transit projects sold $15 billion of bonds this year. Infrastructure borrowing reached a peak of $65 billion in 2010 with Build America Bond federal subsidies. Since then local governments have become more conservative as two-thirds of new bonds issued refinance prior debt for interest rate savings. $3 trillion of work needs to be done by 2020 according to American Society of Civil Engineers.

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PREPA Authorizes Rate Hikes… Municipal bond insurers, mainly Assured Guaranty and National Public Finance Corp, are demanding 100% of par in any PREPA restructuring. Two groups of municipal bondholders that have tentatively agreed to restructuring have extended forbearance to October 15th. A group of institutional investors that hold 35% of the debt agreed to 85% of par with rate changes and extended maturities. Line of Credit lenders, who extended maturities 6 years with lower interest rates, will receive 100% of par. Moving towards a consensus, the PREPA board authorized a municipal bondholder friendly offer to the insurers: higher electric rates, new governance, bondholder representation on the PREPA board and a degree of privatization.

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Puerto Rico Seeks U.S. Guarantee on Debt… Seeking federal help to muster up liquidity, the Island’s non-voting member in the U.S. House proposed a bill that allows the Fed to buy short-term Puerto Rico municipal bonds. The Federal Reserve Act currently authorizes the Fed to buy securities issued by governments in the continental United States. Modeled after the 1975 legislation that allowed the U.S. Treasury to make direct loans to alleviate New York City’s financial troubles, the bill seeks a U.S. Treasury guarantee on certain Puerto Rican municipal bonds issued for short-term financing, capital improvements or refinancing. As a condition to guarantee, the Treasury would have to examine Puerto Rico’s fiscal condition and determine if the common-wealth has shown meaningful improvement in managing its finances. Without a Federally appointed Finance Control Board overseeing the Island’s finances any guarantee of debt is unlikely.

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Select Puerto Rico Bonds Have Value At Current Prices… Investors know there is considerable risk investing in Puerto Rico bonds due to the concentration of credit problems in a single area. However, the Puerto Rico financial crisis has been exacerbated by a significant amount of misleading and confusing media coverage of the island’s financial difficulties. The risk of heightened volatility caused by unfavorable, one-sided media coverage of the Commonwealth and its finances creates “headline risk”. The lack of audited financials and partisan political rhetoric in an election year have intensified the fiasco. All Puerto Rico municipal bonds have come under severe pressure mainly because of “retail” selling related to “headline risk,” and mistrust of the Puerto Rico government. In addition sell recommendations from illinformed financial advi-sors have encouraged direct selling of all Puerto Rico municipalbond issues, even highly rated insured bonds. Governor Padilla intentionally created havoc in Puerto Rico markets. On the April 30th he told the legislature any talk of default is “folly,” which instilled investor confidence. Unexpectedly on June 28th, after he created new taxes, raised the existing sales tax, cut expenses and balanced the budget, he stated the island is unable to pay its debt. Prices on all Puerto Rico municipal bonds crashed, billions of dollars in value were lost as scared, illinformed individual investors sold. Padilla’s objective was to shock the market  and depress prices, which he believed would bring bondholders to the negotiating table and influence the U.S. government to come to the Island’s aid. To date all he has accomplished was to inflict large loses on individual investors. Puerto Ricans own 20% of the island’s outstanding debt and they are suffering from Padilla’s third world government antics. Yields on Puerto Rico debt have risen significantly creating an oversold opportunity in select Puerto Rico issues. Puerto Rico municipal bond issues governed by contract clauses in both the Puerto Rico and the U.S. Constitution protect value for risk oriented investors. Precedent exists for hearing contractual and constitutional disputes in U.S. Federal courts. Puerto Rico Supreme Court decisions can be appealed directly to the U.S. Supreme Court. The Puerto Rico Constitution provides first priority lien on “available resources” of the Puerto Rico Treasury for the benefit of General Obligation (GO) debt service. The priority lien is known as “GO Claw-Back”. The government can claw–back revenues from all revenue sources to pay GO debt. However, COFINA Sales Tax Revenue is the property of Sales Tax bondholders and by law is not part of “GO available resources,” per the opinion of the Puerto Rico Secretary of Justice and municipal bond counsel. To amend current law or the Puerto Rico Constitution would require approval by 2/3’s of the House and Senate plus a special referendum to the electorate. Contract clauses of both Puerto Rico and U.S. Constitutions protect all Puerto Rico municipal bondholders from any government cram-down. The Commonwealth, like U.S. States, is prohibited from filing under Chapter 9 of the U.S. Bankruptcy law. Any debt restructuring will require the consensual agreement of bondholders. The Puerto Rico Electric Power Authority (PREPA) may soon reach a consensual restructuring agreement with municipal bondholders. After the Governor’s June 28th threat that the island is unable to pay its debt, PREPA bonds traded as low as 35 cents on the dollar. In restructuring PREPA bondholders are expected to settle for no less than 85 cents on the dollar, possibly 100 cents as the utility contemplates a rate increase.

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

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