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Muni Week Review / Preview 12/19/2016

Tuesday, Dec 20, 2016

PUERTO RICO GDB PAYS MAY 1st INTEREST AGREES TO FORBEARANCE ON PARTIAL PRINCIPAL PAYMENTS. PUERTO RICO STABILITY ACT (PROMESA) UPDATE. CHICAGO PUBLIC SCHOOLS UNION TALKS PROGRESS.

Puerto Rico Revenue Exceeds Estimates… For the first five months of Fiscal 2017 (July to November) General Funds revenues of $3.37 billion are 4% higher than a year ago and 3.5% more than estimates. The boost comes as excise taxes paid by foreign corporations ($880 million for July to November) were $110 million higher than a year ago and sales and use tax ($1.04 billion for the first five months) surpassed last year’s collections by $140 million. For the month of November, General Fund revenues totaled $533 million topping prior year by $45 million or 9.3%. Expected to be renewed by Commonwealth actions is the 4% excise tax paid by foreign corporations under Act 154 of 2010. The excise tax which accounts for more than 20% of Puerto Rico’s General Fund revenues is scheduled to sunset in fiscal 2017. Governor-elect Rossello’s Chief of Staff has said that an extension of Act 154 will be legislated soon after the new Governor takes charge. Treasury Secretary Zaragoza Gomez said the first six months of the fiscal year are expected to end with a positive balance which is positive for the incoming administration.

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PREPA Restructuring Agreement Extended… Puerto Rico’s electricity company extend-ed its debt-restructuring agreement with creditors until the end of March. By January 31, PREPA and creditors plan to reach agreement on any potential mutually agreed revisions required by the Oversight Board. A year ago, holders of 70% of PREPA’s debt agreed to exchange legacy PREPA bonds for new securities at 85% of par value. Unless changed by PROMESA and the Federal Fiscal Control Board bondholders who do not participate in the exchange will continue to hold their legacy bonds which will not be backed by the new revenue stream. The transaction does require approval from the federal oversight board, which was created after the pact was made. PROMESA’s Oversight Board aims to certify a fiscal plan for Puerto Rico by January 31. President of PREPA’s governing board said, “Today’s actions show the forward momentum of PREPA’s transformation and the willingness of all parties to work together.” Bondholders echoed commitment to the transaction: “The PREPA bondholders believe that the extension of the Restructuring Agreement is a positive step, and believe that it will ultimately lead to the implementation of the PREPA deal by mid 2017.”

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Puerto Rico Governor Fails to Resubmit Fiscal Plan to Board… An update of the much critiqued fiscal plan prepared by Governor Padilla now falls squarely on the seven-member Oversight Board in charge of Puerto Rico’s finances. Governor Padilla refused to add austerity measures to his fiscal plan as requested by the board and skipped the December 15 deadline set by the Federal Board. PROMESA gives the Oversight Board authority to impose fiscal policies if the Governor fails to cooperate. Governor-elect Rossello’s stance on Puerto Rico’s recovery is drastically different and more creditor friendly.

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Puerto Rico Bonds Top Muni Market Returns… S&P municipal bond indexes show overall Puerto Rico debt has gained around 12% in 2016, while the broader municipal bond market barely broke even. Based on PROMESA and early indications from the Federal Fiscal Control Board along with the more bondholder friendly Governor-elect Rossello, at current prices Puerto Rico municipal bondholders should be optimistic going into 2017.

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MOODY’s Report States in a Restructuring COFINA Debt Will Not Receive Preferential Treatment over GO Debt… A Dec. 19th MOODY’s COFINA sales tax bond report stated the Commonwealth of Puerto Rico will avoid imminent default on its Sales Tax Financing Corporation COFINA, senior lien and subordinate lien bonds by making scheduled payments of $19 million in January and $278 million in February. In contrast, MOODY’s expects further General Obligation (GO) defaults, including as much as $400 million due in January. Despite a near term advantage enjoyed by COFINA bonds, in MOODY’s view, holders of this debt ultimately face loss of face value that would be similar to those on GO and other guaranteed securities. COFINA payments have continued because of strong revenue collection mechanics, but that, according to MOODY’s, does not necessarily establish a precedent for superior treatment in a restructuring. The fact that COFINA’s payments have persisted so far under-scores the debt’s credit strengths, but MOODY’s states holders should  not expect that COFINA debt will receive preferential treatment compared with GO debt or avoid being included in a judicial restructuring. COFINA and GO debt both have very strong legal provisions. The Commonwealth’s historical view  that COFINA’s pledged sales tax revenues are shielded from a constitutional claim on “available revenue” in favor of GO bondholders has never been tested in court. As per MOODY’s, excluding either the GO or COFINA bonds from a broad restructuring of Puerto Rico’s central government obligations would provide insufficient relief. MOODY’s expects that the government’s debt will be restructured in court, with the approval of the Puerto Rico Federal Oversight Board. The restructuring will have to encompass COFINA, GO’s and other guaranteed bonds because together they account for so much of Puerto Rico’s debt, about two-thirds of the amount included in the central government’s fiscal plan. GMS continues to believe restructuring of GO and COFINA bonds will be consensual. If restructuring encompasses anything other than extending maturities it should follow PREPA’s example, which resulted in a 15% haircut of face value, a recovery of 85 cents on the dollar.

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Sales of Pension Bonds Fall… Sales of revenue pension obligation bonds totaled just $365.4 million this year, the least since 2011, according to Bloomberg data. Pension bonds are not favored by investors and are penalized by higher yields when they come to market. Next year could represent an up-tick in sales, however, as Houston’s mayor is advocating for the city to sell $1 billion in pension obligation bonds.

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Trump Supports Tax Exemption... President-elect Donald Trump expressed support for maintaining the tax exemption on municipal bonds, according to a delegation from the U.S. Conference of Mayors that met with him last week.

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Longer Maturing Bonds Rally On Low Inflation… Traders have lower inflation expectations as the Fed plans to raise rates in the face of fiscal stimulus possible in the Trump Administration. Tighter monetary policy is expected to be offset by fiscal spending which will keep prices in check. “Break even” inflation or the inflation rate implied by prices of inflation-indexed Treasuries fell to 1.93% from 2%. Last week, the Fed nudged-up the Fed funds target rate by 0.25% to 0.75%. Fed Chair Yellen expects economic conditions to evolve that will warrant only gradual increases in the Fed funds rate. The Fed funds rate is likely to remain below normal levels for some time. Some forecasts place the Fed funds rate around 2% to 2.5% by 2020. The broader outlook for consumer spending growth shows restraint. Auto prices are being slashed as vehicle supply outstripped demand and new home construction fell more than forecast last month. Sales at retailers rose less than forecast in November, after gains in the previous two months. Multiple factors were at play, as energy prices behaved in a typical fashion for the month. Spending related to Hurricane Matthew subsided and tepid income growth constrained households’ ability to spend. A rise in the dollar weighs on prices of U.S. goods sold overseas. On the low inflation outlook, longest dated bonds gained in price as yields fell while prices on shorter maturities’ fell as yields rose on the higher Fed-funds target rate. The gap in yields between short term and long term municipal bonds dropped to about 105 basis points from 128 basis points earlier. A flatter yield curve signals gains for long municipal bonds.

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Muni Yields & Supply… Long term tax-exempt muni bond yields moved lower as trading in the municipal market totaled $17.1 billion, up 8.9% from a week earlier. Next month, municipalities plan to sell $6.87 billion of bonds while three times as many muni bonds, $22.5 billion, will be called or redeemed. Benchmark “AAA” rated Tax-Free Munis yield: 1.25% for 2 years, 2.49% for 10 years and 3.22% for 30 years.

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