The Puerto Rico Aqueduct and Sewer Authority (PRASA) owes 140 million to contractors for completed capital projects; 140 million they do not have. Instead of defaulting on their public bonds which have gross revenue pledges they will likely on their private loans made by other Puerto Rican Agencies like PRIFA and the GDB (which are all arms of the Commonwealth). 

The Puerto Rican Legislature is voting on a bill this week to allow PRASA to create a new (and apparently more secure) entity. The new corporate entity will have a priority claim on a percentage of the water revenues. These revenues will flow directly to this new entity for the sole purpose of paying debt service. The concept is that this "new entity" will be considered a "secure" entity, obtain investment grade ratings, and be able to issue new bonds at attractive yields. 

In 2006, the PR Legislature used the same logic to create Cofina; a new company with priority claim on sales taxes. In this case they received a AA rating and investors lent them over 16 billion dollars under the belief that the sales taxes would secure/support the debt service. Fast forward to 2016 and the Governor and his administration are now suggesting that they were just kidding and that the Cofina entity may not have first claim on these sales taxes.

Hello....does the Puerto Rican Administration/Legislature really think investors are that stupid? 

In 2011, NJ Governor Christie championed new Pension Reform designed to fix the State's massively underfunded Pension system. Fast forward to 2015 and Governor Christie vetoed the 1.57 billion pension contribution required under his 2011 reform. Apparently tax collections fell short of projections and he needed the money to plug the budget gap. 

New Jersey's Pension programs are currently underfunded by more than 40 billion dollars. Governor Christie's  solution is to skip the payment and "kick the can" down the road for the next Governor to address....and round and round we go until one day when there are not enough State revenues to pay for all of the accumulated pension and entitlement liabilities. 

Detroit, Stockton, San Bernardino are all Cities where revenues fell short of expenses. In each case a bankruptcy Judge determined the priority of the liabilities and in each case Pension claims were treated better than bond holder claims. In Detroit, for example, the bankruptcy judge paid 95 cents on the dollar to pension holders and 74 cents to GO Bond holders. 

To be fair, NJ is a State and cannot file for bankruptcy, but the point remains the same. At some point the shoe will drop. NJ bondholders should be very careful.

Yesterday, Fitch rated the upcoming San Diego School District bond issue AAA.

One of our investment themes over the past few years has been that CA local school bonds have been underrated and that the rating agency methodology was wrong because it considered the School District's General Fund as part of their criteria. 

A local CA School District must first get voter approval before issuing any GO debt. Only if the majority of residents in the District agree to pay an additional property tax can the School District issue new bonds. The debt service is paid from these voter approved property taxes which are collected by the County and deposited directly with the Bond Trustee. These taxes are held in "lock box"  form and can ONLY be used to pay the debt service of the bonds. The general fund of the School District never sees, touches, or can use these funds regardless if they are solvent or not. As long as people live in the district, property taxes will be paid, and the bond's will be paid.

The State legislature recently passed Bill 222 which clarifies that the bond holders have a statutory lien on these taxes and more importantly, Orrick opined that these property tax revenues are indeed "Special Revenues" which are levied for the sole purpose to pay debt service. In bankruptcy, "Special Revenues" are not subject to the automatic stay and therefore will not be interrupted.

Fitch has it right now; bond holders have a statutory lien, the property tax revenues are "special revenues" not subject to the automatic stay in bankruptcy, and the County collects these taxes and deposits them directly with the Bond Trustee in "lock box"  form for the sole purpose of paying debt service. Based on the facts above, Fitch no longer considers the financial health of the School District's general fund as part of their rating criteria. 

They are currently reviewing their ratings on the other Ca School Districts and we expect upgrades to occur shortly. Moody's and S&P will likely follow suit.

On July 13, Jerry Brown signed into law SB 222 which makes the sources of revenue supporting voter approved CA School Bonds statutory liens and protected from bankruptcy. 

In most cases, the valuations of the taxable property in these School Districts is 100 times the amount of debt outstanding and bondholders have a senior claim (even to the mortgage bank) to their tax levy on this property. 

The rating agency's rating criterion still includes the School Districts General Fund as well as the flexibility of their School Board; neither of which have any bearing on the sources  that support these bonds. 

The rating agencies are wrong in their methodologies and these security types should have AAA ratings.