Week of 03/01/2021

Puerto Rico Governor Snubs Oversight Board’s Third GO Debt Plan… New Jersey Embarks Full Pension Funding… Sell-Off A “Medium Term Opportunity”…

PR Governor Snubs Oversight Board’s Third GO Debt Plan…For the third time, Puerto Rico’s Financial Oversight and Management Board
(FOMB) has announced a debt agreement for general obligation (GO) and public building authority bonds. The latest plan does not have much needed support from the Puerto Rico administration and lawmakers. Prior general obligation debt plans approved by the board, one in 2020 when former Governor Wanda Vasquez was at the helm and another in 2019 released a month before former Governor Ricardo Rossello was ousted from the top office, failed to pass muster. “Unfortunately, the FOMB has not yet abandoned the pension cuts included in the February 2020 plan of adjustment,” Governor Pierluisi stated “Therefore, the government of Puerto Rico communicated to the FOMB and creditors that it would not be part of the PSA announced today.” The latest Plan offers aggregate $14.4 billion comprising $7.4 billion up-front cash, $7 billion new general obligation bonds and a contingent value instrument in exchange for $18.7 billion legacy general obligation and public building authority bonds. The board said that works out to an average reduction of 27% for general obligation bondholders and a 21% cut for those who own buildings authority debt. The contingent value instrument would pay off if sales taxes exceed targets. Puerto Rico’s tax collections have soared as significant federal aid for disaster relief and COVID-19 flowed to the Island. The new pact cuts debt held by central government creditors from $18.8 billion to $7.4 billion, a 61% reduction and would free up more than $300 million a year for government services. “It will set Puerto Rico on the path to end bankruptcy,” board chairman David Skeel added, “We think this is a very, very big moment in Puerto Rico’s recovery.” Natalie Jaresko, the board’s executive director, said she understood the Governor’s concerns but added that she doesn’t want to presuppose what might happen going forward and what the lack of support from Pierluisi could mean for debt restructuring efforts. Jaresko stated “Hopefully, we’ll reach consensus.” Creditors who participated in the court led debt mediation talks said, “This widely supported compromise will help Puerto Rico avert years of costly, distracting litigation and finally expedite the Island’s long awaited exit from bankruptcy in 2021.” Bond insurers and hedge funds owning about 70% of the debt support the latest plan. “Assured Guaranty has consistently supported a consensually negotiated and comprehensive approach to resolving Puerto Rico’s current financial challenges. It conditionally supports this agreement with the express understanding that the government parties will work with Assured Guaranty to make the agreement part of such a comprehensive solution,” Assured Guaranty noted. The next step is for the board to file the plan in the Title III court ahead of a court hearing. Puerto Rico legislature will need to approve the issuance of new securities for the plan to go forward. PR bonds rallied upon progress on the Island’s eventual exit from bankruptcy. Board and creditor approval for the plan is a step forward. Support from the Pierluisi administration and the Island’s legislature is crucial.

New Jersey Embarks Full Pension Funding…“We’re now on the road to fixing one of the biggest financial problems of any state in America,” Governor Murphy (D) unveiled a $44.8 billion state spending plan for Fiscal 2022. For the first time in 25 years, New Jersey (NJ) will make a full pension contribution. The milestone is buoyed by the state’s surplus. NJ’s pension liability is only about 39% funded. Roughly 14% of the Garden state budget is allocated to pension funding. Murphy’s spending plan is 10% larger than prior year, assumes 2.4% revenue growth and brings a surplus of $2 billion, or just under 5% of budgeted appropriations. Murphy is planning to spend down about $4 billion in surplus and other reserves that are expected to build up by the end of June. Last Spring, sales tax revenues dropped, casino tax collections fell and gas tax collections were cut. New Jersey’s credit rating took a blow in April 2020 when Fitch cut its rating by a notch, followed by S&P’s downgrade in November 2020. Recent state tax revenue has outperformed projections. More than $38 billion in federal stimulus funds for enhanced unemployment benefits, stimulus checks and paycheck protection program loans led New Jersey revenues to soar. Like many other states, New Jersey budget officials projected big declines in tax revenue following the business closures put in place to curb the spread of Covid-19. At that time, New Jersey estimated a two-year budget shortfall of about $10 billion. Dire predictions did not come true. Moreover, much of COVID-19 emergency borrowing remains unused and will fund higher spending in Fiscal 2022. Last year, the Supreme Court stepped in to approve Murphy’s borrowing plan when the Democrat led government sparred with Republicans. New Jersey Constitution generally prohibits using borrowed money to fund current spending, but it allows for exceptions such as responding to war or a major emergency. In retrospect, Murphy said it was prudent to take on low cost debt, rather than make deep spending cuts and leave pensions unfunded. Having scored a win by enacting a Millionaire’s Tax last year, Murphy has veered away from higher taxes in his fourth budget. The windfall from stimulus led outperformance has allowed Murphy to make a full pension contribution, a year ahead of schedule. Budget talks with the Democratic controlled state Legislature will start soon. “The problems in our pension system, rather, have everything to do with past administrations, of both parties and going back 25 years, who simply and shortsightedly decided not to pay. In fact, some suggest, even today, that we skip out on our pension obligation,” Governor Murphy said. “We won’t go back to those failed, old ways.” For sustainable pensions, reform is a must and fixes from one-shot revenue come with a grain of salt. In an election year, all eyes are on ratings agencies’ view of the Garden State. The second lowest rated state’s plan to arrive at a full pension funding milestone a year ahead of schedule should not be frowned upon by ratings agencies.

Sell-Off A “Medium Term Opportunity”…Higher muni market yields are termed as a “medium term opportunity” by Barlcays Plc muni strategists who added “In the past five years, there were several instances of large Treasury rate sell-off, including the current one and in most cases munis outperformed with high yield usually the best performer,” “The current sell-off will not be any different.” Top rated tax-free bonds yield about 85% of comparable taxable U.S. Treasuries, reflecting a higher value in bonds issued by states and local governments.

Compare 30-Year taxable U.S. Treasury yield 2.20% to 30-Year tax-exempt muni bond yield “AAA” 1.87%; “AA” 2.14%; “A” 2.31%; “BBB” 3.06%. For investors in the 35% tax-bracket, a 3% tax-exempt yield is equivalent to a 4.62% taxable yield. Top rated tax-free bonds yield 85% of comparable taxable U.S. Treasuries.

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