Public Finance Attorney David Fernández of Buchanan, Ingersoll & Rooney PC talks about the effect that an interest rate increase will have on the municipal bond market. He also takes a look at the situation in Puerto Rico and says the Commonwealths action on Jan. 1, 2016 will set the tone for the rest of the year.
FERNANDEZ: I think the rate hike could actually help the market long-term. For too long, the market has-- the rates have been so low that the reasons why you would want to use the muni market as opposed to going conventional really didn't exist. All the incentives that were there for the muni market bonds that tax-exempt status and all those things and all of the other types of benefits that accrued to those types of bonds weren't really making it worthwhile to do them when you could go conventionally and not have all the regulations, all the obligations, all the covenants and all those things attached to them.
With the rate hike, you're going to start to see a little bit of a spread there. You might start seeing some of those deals that may have been borderline because they weren't going to be done conventionally or that you might start seeing them on tax-exempt now and it might increase the market a little bit. That'll take some time. It's not going to happen right away. A rate hike will help the market address the projects that may not necessarily have been able to avail themselves to financing beforehand.
If the rate gets higher and the spread between a tax-exempt debt and a conventional debt becomes more acute, you start seeing projects that may not necessarily been financeable under a conventional project scenario, be financeable under tax exemption scenario. On the flip side of that, there's more receptiveness to having all the covenants reporting requirements and things of that nature that come with a municipal debt and tax-exempt obligation if the cost of lending or the cost of borrowing is such that it makes it much more tolerable to the borrower into the institutions to take on that debt.
When the line is so close that really doesn't exist. There's really a less disincentive to the lending in that particular situation. The parallel now between now and the '70s is, in the 70s, you had New York City. New York City was in the verge of bankruptcy, we had Washington being very recalcitrant, we've had Gerald Ford telling New York City to drop dead, that Washington was not going to bail them out. Fast forward to 2015, we have Puerto Rico, we have Illinois, we have California. We have a whole bunch of different situations where we have municipalities repressive edging on the precipice of bankruptcy.
We have a recalcitrant Congress, we have a recalcitrant Washington saying, "We're not going to help you out." It's a little bit different in this circumstance. We have more than just one entity involved but the politics look like they're the same in certain regards. The solutions could be similar if they're made available. The difference between New York in the '70s and Puerto Rico in the 2015, is you have Puerto Rico doesn't have Chapter Nine available to it, Puerto Rico doesn't have sales tax revenues available to it, Puerto Rico doesn't have a whole bunch of other avenues that could be used as life rafts to help restructure their debt.
Whereas, New York City was able to restructure themselves using some very creative legislative mechanics to get themselves into a position where they were able to refinance and restructure their debt and work themselves out, which ended up happening pretty successfully. That's the parallel between now and then. Puerto Rico going into 2016 is going to be a very important factor in determining how it's going to play out over the rest of the course of the year. The bond payment that's due on January 1st is going to set a specific tone as to how Puerto Rico addresses that.
The situation that their facing is without having the capacity of doing Chapter Nine Bankruptcy without having a discernible revenue stream in which they can restructure their debt with or without having the ability consolidate all their debt create a super bond per se or some other types of fiscal oversight type of solution. It's going to require a lot of active parts coming together and meeting of minds to come together to try and make things work. Having Washington be very recalcitrant in regards to providing them with the tool that they need in terms of Chapter Nine and basically telling Puerto Rico that they were not going to provide them with a federal bailout sets the stage.
Without having that Chapter Nine in their toolbox, it doesn't give incentive to the creditors, it doesn't give incentive to the bond insurers, it doesn't give incentives to the creditors to actually step up to the table and say, "We are going to negotiate this because we don't want this to go into bankruptcy. How can we find a way to make sure that this works?" If Puerto Rico, when they get to that January 1 payment has two decisions to make. They have to decide, "Are going to pay the debt? Are we going to take from Peter to pay Paul? Are we just going to default on the debt?"
The decision that they make is going to set the stage. Because if they just pay what they can and they default on the debt that comes due, you're going to have those creditors stepping up and trying to accelerate that debt. If they take from Peter to pay Paul, all of a sudden now you have all of these other issuers, other issuances that may not necessarily have been in default are now in covenant default and now you have a lot more disgruntled holders and the negotiating tool becomes even more difficult.
On top of that, without having bankruptcy protection, they have to try and go into the courts and figure out how to do it. Creating a fiscal oversight can board or fiscal oversight authority try to create a place in which they can try and restructure the debt and come out with a new financing stream or structure that works is something that's an option.
But when you have a very limited resource pool of revenues that are coming into the Commonwealth in terms of fees and structures and revenues and sales taxes and that kind of thing, you really need to be cognizant of what you're dealing with. Colfina holds the cards because they hold the sales tax revenues, those holders are going to play a very important role in any restructuring. That's how it's going to play out. January 1 and how the Commonwealth addresses that payment is going to set the stage for the rest of the year.