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PUERTO RICO’S REPUDIATION OF GENERAL OBLIGATION BONDS
PUERTO RICO’S REPUDIATION OF GENERAL OBLIGATION BONDS: A REAL RISK OR JUST KABUKI THEATER
By James E. Spiotto
On January 14, 2019, the Financial Oversight and Management Board, acting through its Special Claims Committee and the Official Committee of Unsecured Creditors, filed an objection to the validity and enforceability of more than $6 billion of the Commonwealth of Puerto Rico’s General Obligation Bonds. The purported reason for the invalidity was the asserted violation of the Commonwealth’s Constitutional Debt Service Limit found in Article VI, Section 2 of the Puerto Rico Constitution, as amended in 1961, which provides that direct obligations of the Commonwealth “shall not exceed 15% of the average of the total amount of annual revenues…” (“G.O. Debt Limit”). This claim of invalidity was asserted long after the issuance of the General Obligation Bonds, in which the Commonwealth and its professional represented that the Bonds complied with the Constitution and laws of Puerto Rico and were a valid, binding and enforceable obligation, and released to the market a calculation of compliance of the issuance with the G.O. Debt Limit. In addition, there also is a claim by the objecting parties that issuance of the $6 billion of General Obligation Bond Debt violated the Balanced Budget Clause of the Puerto Rico Constitution, Article VI, Section 7 providing “the appropriation made for any fiscal year shall not exceed total revenues including available surplus estimated unless the imposition of taxes sufficient to cover said appropriation is provided by law” (“Balanced Budget Clause”). These claims of invalidity when carefully reviewed from a historic perspective should be rejected.
Repudiation or claims of the invalidity of previously issued general obligation bonds by states or even local governments historically have never been viewed by the market as an acceptable or respectable position for an issuer who had earlier represented, through its statements and its agents, that the bonds were valid and in compliance with the law. Generally, constitutional debt limits or balanced budget requirements are guide posts for the governmental issuer in conjunction with bond counsel prior to actual issuance to determine whether such debt can and should be incurred. These provisions were not intended to create an artifice that clever government issuers could spring on unsuspecting good faith bond purchasers who had no prior notice of any defect and in fact were told at issuance there were no compliance problems with the constitution and law of the government. Nevertheless, efforts by states and local governments to repudiate or invalidate debt after its issuance contrary to what they represented to induce the purchase of bond debt by good faith purchasers are not new. Such attempts to invalidate or repudiate state and local government debt in the United States first took place in the 1800’s. The lessons learned from those unfortunate efforts should not be forgotten and are instructive as to the current attempts of Puerto Rico to invalidate certain of its G.O. Debt.
History of Repudiation
In the aftermath of the panic of 1837 and the need for states to borrow to pay for transportation improvements in the North (given the success of the Erie Canal) and for banking services in the South, 19 out of 26 states and two territories borrowed money for economic growth. By the 1840’s, eight states and one territory defaulted on those borrowings and repudiated those debt obligations. Those issuers that repudiated the debt then experienced either an inability to borrow additional funds or, if they could obtain financing for needed governmental improvements and services, suffered the imposition of a 32%+ yield. By the late 1840’s, seven of the eight states had renounced their repudiation and resumed payment on the debt in order to obtain market access at a lower cost. The state and one territory that were left repudiating their debt struggled for over a decade to obtain funds, let alone at a reasonable cost.
After the Civil War, in response to suggestions that the government should discount the cost of war debt by paying it in greenbacks as a devalued currency, President Grant, in the spirit of Washington and Hamilton eighty years earlier, chose to protect national honor. He stated every dollar of the government indebtedness should be paid in gold. Unfortunately, such was not the fate of the failed confederate government’s war debt. By means of the 14th Amendment, debt incurred in aid of insurrection was deemed illegal and void.
Worried About Public Pensions? Counties Often Have Lower Burdens
Counties Often Underappreciated Despite Generally Improving Fund Balances and Lower Debt and Pension Liabilities
By Richard A. Ciccarone
County governments are generally a good place to start your search for governments with positive financial conditions as well as lower pension and debt liabilities. Since the Great Recession and Credit Crisis, counties have shown improving general fund balances, lower debt and better pension funding ratios. These strengths often get overlooked by public finance critics as well as anxious municipal bond investors that are rightfully concerned about the potential retirement burdens impacting many states and cities.
General Fund Balance Trend
One of the best measures to assess operating reserves is to take a look at the general fund balance in comparison to annual expenditures. For fiscal year 2017, the median general fund balance to expenditures was 38.9% based on a sample of 1,107 U.S. counties by Merritt Research Services, LLC, an independent municipal bond data and research company. As shown in the table below, the total fund balance ratio is about 10% higher in 2017 than it was in 2009. based on Comprehensive Annual Financial Report audits collected by Merritt Research.
Available Fund Balance
The portion of the fund balances that is available for future spending and reserves is defined by the Governmental Accounting Standards Board as the assigned or unassigned fund balance. The assigned designation refers to balances that are legally designated by statute, resolution or indenture while the unassigned refers to the portion that is totally uncommitted. Converted into a narrower fund balance ratio, this figure is also running on a positive high note.
Most counties have a comfortable margin, providing them with reserves and room to maneuver as evidenced by ….
Fiscal Year 2017 Municipal Bond Audit Times Are Still Too Slow
Municipal Bond Audit Times Show Slight Improvement Since 2015 But Most Still Late to the Table — The County, State and City Sectors are the Least Timely
By Richard A. Ciccarone
Municipal bond analysts and investors are accustomed to waiting a lot longer for municipal bond financial audits to be completed after the close of the fiscal year than they would on a corporate bond. While public corporations are required to file an annual audit within 60 to 90 days after the close of the year, municipal bond borrowers often finish their audited annual reports in close to twice that time and a large number take even much longer.
While investors need the audit documents for credit evaluation and securities pricing purposes, they are not the only stakeholders that have a need to see timely audited financial reports. Governing boards associated with public bodies and not-for-profit organizations need to review the audits in order to fulfill their duty for proper oversight. Like municipal bond analysts and investors, they are better able to respond to issues disclosed in an audit if the documents are timelier. Although this issue has been lingering for decades, the time it takes to complete and sign an audit after the fiscal year has been completed hasn’t changed much over the last ten years.
Featured Bond: State of Louisiana — $309 Million General Obligation Bonds
Featured Municipal Bond Issue: State of Louisiana to sell $309.8 Million General Obligation Bonds by Competitive Bid on February 21, 2019
Our featured new issue municipal bond of the week is the State of Louisiana .
The State of Louisiana plans to sell general obligation bonds, Series 2019 A, by competitive bid in the amount of $309,845,000 on February 21, 2019.
Bond Proceeds will be applied to capital outlay purposes as authorized under the State Constitution.
The bonds are general obligations of the state of Louisiana, and the full faith and credit of the State is pledged to pay the principal and interest on the bonds when due. The bonds, together with other general obligations of the state, are payable from funds pledged and dedicated to and paid into the Bond Security and Redemption Fund as described in the State Constitution.
The 2019 Bonds are rated Aa3 by Moody’s, AA- by Standard & Poor’s and AA- by Fitch.
For the full article with a statistical snapshot of financial measures, click here.
Feb 25, 2019 - February 25, 2019
Nelson A. Rockefeller Institute of Government , 411 State Street
Mar 25, 2019 - March 27, 2019
Omni Austin Hotel Downtown , San Jacinto Boulevard
Mar 27, 2019 - March 29, 2019
Renaissance Nashville Hotel , Commerce Street
Apr 16, 2019 - April 19, 2019
Music City Star Riverfront Station , Nashville