The effort to protect timely debt payments on special revenue bonds will shift to enacting new state laws in light of Monday’s Supreme Court announcement it won’t consider an appeal of a Puerto Rico case.
“Now is the clarion call that an appeal is not going to work so whether it is the GFOA or the National League of Cities, or other governmental entities, it’s important to have everybody on board,” said James Spiotto, managing director of Chapman Strategic Advisors in Chicago.
Monday's announcement was the first of two involving Puerto Rico that are expected this month from the high court.
The justices are expected to also release their ruling in a lawsuit begun by Aurelius Investment and other hedge funds that want the court to invalidate all actions taken by the Financial Oversight and Management Board for Puerto Rico. If a majority of the justices find the Oversight Board created by Congress has a primarily federal role, it could do what the hedge funds want or at least what an appellate court ordered, which is require U.S. Senate confirmation of a new board.
The Oversight Board argues that Congress had the authority to establish the board as a primarily local body under Article IV of the Constitution, which empowers Congress to admit new states and administer the territories.
The announcement Monday involved last March’s ruling by the First Circuit Court of Appeals involving the Puerto Rico Highways and Transportation Authority’s special revenue bonds. Assured Guaranty and two other bond insurers petitioned the Supreme Court to accept an appeal.
Bankruptcy attorney John Mudd in San Juan, who represents unsecured creditors in Puerto Rico’s bankruptcy, said he wasn’t surprised by Monday's denial because only a small fraction of cases are considered.
The case law on the protected status of special revenue bonds is different from last year’s First Circuit appellate court ruling and that ruling only applies to the appellate court jurisdiction in New England and Puerto Rico, Mudd said.
The decision will only have wide implications if another appellate court issues a similar ruling, according to Mudd.
However, since that ruling credit ratings agencies have changed their ratings criteria and have downgraded some municipal issuers.
Spiotto, an expert in municipal bankruptcy, last year published a model state statute in the Municipal Finance Journal that would ensure timely payments on special revenue bonds even when a local government or agency has filed for federal Chapter 9 bankruptcy protection.
Some states, such as California, already have such laws on the books.
State legislatures are beginning their 2020 legislative sessions this month, so it’s an ideal time to introduce this legislation, Spiotto said.
“It’s important to have borrowing costs as low as possible because there’s no justification to having higher borrowing costs,” said Spiotto, who estimates last March’s ruling by the First Circuit of the U.S. Court of Appeals has increased borrowing costs 20%-25% over the duration of a long term bond.
“The First Circuit didn’t take away the validity of the lien,” said Spiotto. “What it did do, is raise the question of timely payment which will possibly lead to lower credit ratings or downgrades of existing bonds which will increase the borrowing costs.”
On a positive note, the appellate court did recognize the authority of states to require payments on special revenue bonds in a bankruptcy.
Spiotto said he hopes the National League of Cities, the Government Finance Officers Association and other groups will use Monday’s Supreme Court announcement as a signal to begin work with state legislatures to enact similar statutes.
The hope that the high court would accept the Puerto Rico case rested on the conflict it created with protections afforded to revenue bonds in other Chapter 9 bankruptcy cases involving the cities of Detroit, Stockton, and San Bernardino as well as Jefferson County and others.
State law can always be changed by federal law, Mudd said, suggesting that a federal law would be the better option than enacting model state statutes.
Matthew Fabian, managing director of Municipal Market Analytics, said in an email Monday that although the Puerto Rico case “only directly impacts borrowers within the First Circuit,” the Supreme Court’s decision to not hear an appeal “has given revenue bond issuers nationwide a slightly better reason to file for chapter 9.”
“Municipal investors are being compelled to think about any revenue bond’s connection to a government that might file for bankruptcy and to integrate GO [general obligation bonds] with revenue bond credit analytics,” Fabian wrote. “There could be some spread widening for revenue-structure-dependent credits, like Chicago’s STSC, O’Hares, or even the new COFINAs, but this is apt to be slight in the current market.”
