Week of 7/15/2019

Fed Signals July Interest Rate Cut… Fraud Allegations in Puerto Rico Bring Governor Rosselló’s Administration To A Crossroads… Oversight Board Vs Governor Rosselló Conflict Escalates… Record High Puerto Rico Revenue… Hartford, CT Financial Recovery Validated By S&P, Moody’s… Steady Inflows to Munis Continue…

Fed Signals July Interest Rate Cut…On Capitol Hill, Fed Chair Powell testified that “the case for a somewhat more accommodative monetary policy had strengthened” since the Fed’s June meeting. At the June Fed meeting, Fed members discussed their reasons why lower interest rates might help the economy. Some thought that lower interest rates could “help cushion the effects of possible future adverse shocks to the economy while others cited weak inflation and labor market woes”. Many Fed members “judged additional monetary policy accommodation would be warranted in the near term”. When asked this week on whether the recent uptick in jobs suggested potential economic improvement, the Fed Chair replied, “The straight answer to your question is ‘no.’” Chairman Powell stressed that “There is a risk that weak inflation will be even more persistent than we currently anticipate” due to cross-currents from trade tensions and weak global growth. Chairman Powell did not indicate if the Fed would cut rates by 50 basis points or 25 basis points. The bond market is 100% certain that rates could be cut in July, vast majority of traders anticipate a 25 basis point cut.

Fraud Allegations in Puerto Rico Bring Governor Rosselló’s Administration To A Crossroads…Sweeping fraud allegations within the Rosselló Administration involving federal funds between 2017 and 2019 could bring the Island territory to a turning point. Federal indictments this week have brought to a head a governance crisis in Puerto Rico that cut off the Island’s capital access. Governor Rosselló is being asked to resign and, the spotlight is also on the seven-member Federal Board in charge of overseeing Puerto Rico’s finances. Telling federal indictments ratify bondholders’ fears and invalidate the Rosselló Administration’s suspect pleas in the Title III court. The FBI unearthed a sprawling complex of government fraud while Governor Rosselló was vacationing overseas this week. A day after federal agents interviewed Rosselló’s chief advisor, the FBI arrested and charged current and former officials of Puerto Rico Gov. Ricardo Rosselló’s Administration for steering federal money to unqualified, politically connected contractors for three corruption schemes, five types of charges, on 32 counts involving $15.5 million of federal funds between 2017 and 2019. Charges include wire fraud conspiracy, conspiracy involving theft, wire fraud, money laundering conspiracy, and money laundering against six people including Puerto Rico’s former Education Secretary, former head of PR Health Insurance Administration and the President of BDO Puerto Rico accounting firm, which is an auditor for several Puerto Rico government agencies. Indicted individuals used their political influence to improperly obtain contracts, and then used that money for illegal lobbying per United States Attorney for Puerto Rico Rosa Emilia Rodríguez Vélez who added that fraud involved several municipalities as well as “new accusations” coming although she assured the Governor was not part of the ongoing investigation. FBI has seized the computer and iPad that former Secretary of Treasury Raul Maldonado Gautier had used until ten days ago when Governor Rosselló dismissed him for announcing on public radio that an institutional mafia exists within high levels of the Island’s government. The corruption scandal has overtones from the tenure of Rosselló’s father, Pedro Rosselló, former governor 1993-2001, also beset with corruption scandals and arrests. “We repudiate once again these schemes that are the product of people guided by personal interests and greed,” Puerto Rico Secretary of Justice Wanda Vasquez Garced said there are over 28 cases of corruption involving public officials that the Puerto Rico Dept of Justice has investigated or referred to special independent prosecutors and federal authorities. Capitol Hill is equally concerned because U.S. Congress approved $42 billion, U.S. taxpayer dollars, for the Island’s recovery. So far, only about $14 billion of that money has been spent in part because President Trump called Island officials “incompetent or corrupt.” “The Trump Administration will not put taxpayers on the hook to correct a decades-old spending crisis that has left the Island with deep-rooted economic problems,” a White House spokesman said earlier this year. Rep. Raúl M. Grijalva (D-Ariz.), chairman of the Natural Resources Committee that oversees Puerto Rico, called on Rosselló to resign amid the ongoing federal investigation. “We’ve crossed that crucible now. The restoration of accountability is so key going forward,” said Grijalva, who reiterated that he supports Rosselló’s resignation. Many members of the Governor’s Progressive National Party and Puerto Rico Resident Commissioner Jenniffer Gonzalez also support the resignation over a spate of profanities from Rosselló towards prominent public figures. The federal indictments underscore bondholders’ arguments for stronger Federal Oversight of the Island and strengthen the case for equitable bondholder recovery in Puerto Rico’s Title III debt restructuring. Bond insurers and bondholders have repeatedly pointed out the Island’s robust tax collections, government cash hoard and a resurgent economy to a covert administration which tried to hide Puerto Rico’s true financial picture. As the truth is uncovered, it is becoming apparent that the Island territory does not face a debt crisis, but a governance crisis. U.S. Congress and the Federal Title III court must recognize that Puerto Rico’s bondholders, on the Island and the mainland, deserve better. FBI findings could prove consequential in bringing effective Federal Oversight to the Island and transparency to bondholders.

Fed Board Vs Governor Rosselló Conflict Escalates…The Puerto Rico Oversight Board sued Gov. Ricardo Rosselló over unauthorized spending and lack of financial discipline. Three illegal laws enacted recently by the Governor run foul of PROMESA per the Oversight Board. One: The Board objects to Law 29, signed by the Governor in mid-May, which ends municipalities’ responsibility to reimburse the central Puerto Rico government for retiree pension costs; Two: the Board has challenged two dozen expense appropriations that are not in the board-approved budget; Three: the Board has asked the Title III court to declare the governor’s practice of failing to provide laws for board financial review to be illegal. The Board could move for summary judgement as early as next week and will be heard in the courtroom in early August.

Record High Puerto Rico May Revenue…Puerto Rico’s May 2019 revenue, $922 million or 20% higher than projected, is the highest May collection on record. Puerto Rico is expected to end Fiscal 2019 with $11.3 billion General Fund revenue, which is 33% or $2.8 billion higher than projected a year ago. The revenue outperformance is due to higher economic activity, new tax laws that came into effect January 2019 and improved tax compliance.

Hartford, CT Financial Recovery Validated By S&P, Moody’s…Hartford’s financial recovery efforts have been validated by both S&P and Moody’s this year. Last week S&P changed its outlook from stable to positive following Moody’s upgrade from “B2” to “B1” in March this year. Hartford’s credit profile was bolstered after significant state oversight through the Municipal Accountability Review Board, state assistance with certain GO debt service and savings from union contracts. “In our view, the city’s underlying credit profile, despite its economic and taxing challenges, has improved and we believe there is a one-in-three chance the rating could improve to investment-grade in two years, provided it continues to produce balanced operating results in accordance with its financial recovery plan,” an S&P analyst noted the city’s “balanced operations and greater operating flexibility to address capital and service delivery.” Hartford Mayor Luke Bronin said, “For the first time in a long time, we have a serious, transparent financial plan that gives us a foundation to build on.”

Steady Inflows to Munis Continue…The Fed’s rate cut signals are boosting demand for fixed income. For 27 weeks, investors have favored municipal bond investments. Puerto Rico, COFINA, New York and California munis were actively sought in last week’s muni market. This week $7 billion of new muni issues are expected which include an “A1” rated toll road system in Texas, a children’s hospital in Atlanta and Colorado healthcare facilities. Long term top-rated tax-free munis yield 2.38% or 90% of the comparable taxable U.S. Treasury yield 2.65%: reflecting attractive prices.

Compare 30-Year taxable U.S. Treasury yield 2.65% to 30-Year tax-exempt muni bond yield “AAA” 2.38%; “AA” 2.56%; “A” 2.77%; “BBB” 3.26%.