During the latest quarter, additional Puerto Rico credits filed for debt restructuring under Title III of the Puerto Rico Oversight, Management and Economic Stability Act (“PROMESA”), including the Employee Retirement System (“ERS”) with $3 billion of bonds outstanding, the Highways and Transportation Authority (“PRHTA”) with $6.3 billion of bonds outstanding, and the Puerto Rico Electric Power Authority (“PREPA”) with approximately $9 billion of outstanding bond debt. PREPA’s Title III filing followed rejection by the Financial Oversight and Management Board for Puerto Rico (“FOMB”) of a restructuring support agreement (“RSA”) that had been carefully negotiated over the course of three years between PREPA and its creditors. Rejection of the RSA by the FOMB is viewed by PREPA bondholders as a violation of PROMESA, which had specifically excluded preexisting consensual agreements from its powers, and PREPA was the only entity with a restructuring agreement in place as of the legislation’s passage.
Court-ordered mediation of lawsuits related to ERS, PRHTA, and PREPA, as well as for the Commonwealth’s General Obligation Debt and Sales Tax (COFINA bonds) started in mid-July. In total, these entities represent $47.5 billion of the Commonwealth’s $74 billion of total debt, excluding outstanding pension liabilities. The first negotiated restructuring was recently approved, with the FOMB approving a restructuring of the Government Development Bank’s (GDB) $4.8 billion of debt, requiring bondholders to take a 25% to 45% haircut. Despite the initial restructuring of the GDB’s debt, we expect the Title III proceedings for other agencies to continue for an extended period due to the various conflicting interests of both the creditors and the government entities involved.
With ratings pressures mounting and the increased risk of losing its investment grade rating looming, the State of Illinois passed its first budget in almost 2 years, after an override of Governor Bruce Rauner’s veto by the state legislature. As a result, all three major rating agencies affirmed the state’s investment grade rating in July, stopping the bleeding as the state has experienced eight ratings downgrades over the past 2 years. S&P affirmed its BBB- rating while removing the state from CreditWatch, while Moody’s and Fitch affirmed their Baa3 and BBB- ratings, respectively, with both agencies maintaining a negative outlook. The $36.1 billion budget provides for $2.5 billion in spending cuts and $5 billion of new tax revenue, which resulted in credit spreads improving 40-55 bps on Illinois bonds on the first day of trading after passage, with additional tightening in subsequent trading. The State still faces a daunting $15 billion backlog of amounts owed to vendors, but the budget allows the state to borrow approximately $6 billion to pay down the backlog. The enacted budget provides some much-needed liquidity and is expected to provide some pension savings based on new options for new hires at school districts and universities, but the state is far from out of the woods with its unfunded pension liability now at over $126 billion and no significant structural changes that will reduce the pension burden.
Part of the ongoing battle in Illinois involves funding the Chicago Public School (“CPS”) system, which the has been in financial distress for several years. The problem stems from legislation that was enacted over 20 years ago, which provided the State greater flexibility in the amount of money funded into the Chicago teacher’s pension fund in exchange for increased grant funding from the State. The intent was to provide CPS with more autonomy on how their funds are spent, but required CPS to pay more into the pension system. After several years of declining enrollment and using funds to cover operating deficits, the Chicago teacher’s pension fund now has a $9.6 billion deficit and has been seeking additional funding from the State. On August 1, 2017, Governor Rauner used his amendatory veto powers to reject recently approved legislation that Rauner has called a “bailout” for CPS. The move by Rauner threatens to remove $250 million of block grants for CPS and would remove reimbursement for CPS pension costs from the state’s school funding formula. CPS has been paying a significant price in the capital markets for their financial distress, with yields on new recent bond issues exceeding 7.6% and existing variable rate debt reaching 9% yields. With an ongoing structural deficit and continued declining enrollment, we expect the situation with CPS to continue to deteriorate, which will provide opportunities for distressed debt investors.
The City of Hartford received another downgrade to junk when S&P downgraded the city from BBB- to BB in July, with Moody’s rating already at a Ba2 junk level. In preparation for a potential bankruptcy, the City engaged Greenberg Traurig LLP as a restructuring counsel. Hartford’s woes are attributed in part to the lack of property tax revenue due to the number government owned buildings in the City, which are exempt from taxes. Mayor Luke Bronin continues to seek additional state aid to help with the City’s shortfall, but with Connecticut facing a $5 billion deficit and no FY 2018 and FY 2019 biennial operating budget passed, the City cannot determine what state assistance it will receive, if any. The City currently has approximately $700 million of debt outstanding, which may be in default within the next six months if the City doesn’t receive additional assistance.