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Between a rock and a hard place
After narrowly averting default earlier this month, Puerto Rico may not be able to pull another rabbit out of its hat for its next debt deadline. Many observers believe the U.S. territory will miss a $36.3 million principal payment on Public Finance Corp. bonds that's due Aug. 1. For one, the legislature didn't include the payment in this year’s budget. Meanwhile, a federal bailout appears unlikely and a congressional bill that would let some of Puerto Rico’s agencies declare bankruptcy isn't moving forward. Taking all of that into account, Standard & Poor’s this week said it’s a “virtual certainty” that it will miss the upcoming payment, while Moody’s Investors Service said “the probability of default is approaching 100 percent.”
Of its $72 billion in outstanding debt, about one quarter ($18 billion) is legally protected securities primarily made up of general obligation (GO) bond and guaranteed debt. If Puerto Rico restructures its debt, GO bondholders have legal priority to get paid over other types of bondholders. And the island has already started restructuring talks with Wall Street creditors this month. But because the GO bonds account for such a significant portion of Puerto Rico's debt and because the island suspended a legal requirement to set aside money for its monthly GO debt payments, Moody's cautioned that these bondholders could see haircuts as big as 35 cents on the dollar in a debt restructuring. Unsecured bondholders, however, could see cuts as big as 65 cents on the dollar.
Puerto Rico’s situation is fairly unique. As neither an independent nation nor a state, the territory doesn't have voting representation in Congress and lacks the same legal bankruptcy rights as those in the states. U.S. states can’t file for bankruptcy themselves, but cities and school districts can in many places. While most cities and states have started to recover from the recession in 2008, Puerto Rico’s economy has been in a recession for nearly a decade. And unlike Greece, Puerto Rico can't turn to a lender of last resort, such as the International Monetary Fund.
One step forward, two steps back
Back in the states, this week brought a mixed bag of good and bad news for municipal governments.
Let’s start with the good news. Credit ratings agencies thought Atlantic City, N.J., wouldn't make it through the summer without defaulting on its debt, but a Moody’s analysis reported that "America's Playground," which the agency rates at junk status, has enough cash to meet its August GO debt payments and that reserves should be sufficient through Nov. 1 to cover operations and debt service. Moody’s called this development a "credit positive" but added that there's still more that could be done to help the city's financial footing. This includes, Moody's said, passing the pending state legislation to rescue Atlantic City, striking favorable negotiations with casinos that still owe taxes and closing a $101 million structural budget deficit.
Meanwhile, developments for other distressed localities have gone the other direction this week. In Michigan, a financial review team backed by Gov. Rick Snyder declared a state of financial emergency for Wayne County (which includes Detroit). The team cited major discrepancies between budgeted expenditures and actual ones in the county’s last four annual financial audits, zero agreement among officials on how to pay for badly needed jail upgrades, and $1.3 billion in health care-related liabilities that are eating up 40 percent of the county’s long-term financial obligations.
In Houston, there's a problem. Although not labeled as distressed, some think it ought to be. Earlier this month, Moody’s changed Houston’s credit outlook to negative, citing “growing pensions costs and liabilities, which are compounded by significantly limited revenue raising flexibility, and projected structural imbalance.” Last year, pensions, retiree health care and other debt totaled a whopping 30 percent of the city's budget. The pension debt growth is particularly alarming because its current $3.2 billion liability is nearly double the liability reported five years ago. One watchdog group estimated that Houston's overall debt is nearly equal to Detroit's debt before the Motor City filed for bankruptcy in 2013. And this week, political blogger Don Hooper called on city officials to fess up to the instability and file for Chapter 9.
“Only recently did the city’s finance director announce that the city is out of magic tricks,” wrote Hooper in a post for Big Jolly Politics. “They have sold every city asset with any value and these one-time cash infusions used to balance the city budget are over. It took us a few years to get here; but, I am now of the opinion that it is time to file for bankruptcy.”
The Medicaid elephant in the room
A new report from Fitch Ratings looks at how states are handling the rising cost of Medicaid, which is taking up more and more of state budgets. Medicaid spending has increased, on average, between 6 and 7 percent a year over the past 20 years; meanwhile, state tax revenues are only increasing 4.5 percent a year. Implementation of the Affordable Care Act has affected state budgets, but not enough to significantly alter the cost trends, according to the report. Still, noted Director Eric Kim, efforts by some states are helping.
“Some states are shifting away from fee-for-service payments and towards managed care, while others are cutting reimbursement rates or limiting the types of benefits provided,” said Kim in a press release. “These efforts have been successful to some extent at slowing growth, but it will continue to be a formidable challenge.”