Category: Credit risk

PREPA bond parties make offer and file suits

Mary Pat Campbell

Link: https://fixedincome.fidelity.com/ftgw/fi/FINewsArticle?id=202311131617SM______BNDBUYER_0000018b-ca27-d799-afbf-dbf739470092_110.1

Excerpt:

Puerto Rico Electric Power Authority bond parties that oppose the Oversight Board’s proposed debt deal filed suits challenging part of the deal, asked for compensation for Puerto Rico central government’s actions since March 2022 and proposed an alternate bond deal.

The parties filed the suits this weekend in the U.S. District Court for Puerto Rico and filed an informative motion Friday in the bankruptcy telling U.S. District Judge Laura Taylor Swain about their bond deal offer.

GoldenTree Asset Management and Syncora Guarantee sued Puerto Rico’s central government for actions taken since March 2022 to interfere with PREPA’s ability to pay bondholders. The court has yet to appoint a judge in that case.

The bond parties allege the commonwealth government has manipulated PREPA’s fiscal plans and budgets to deprive the bondholders of their claim on the authority’s revenues and depress the value of the bonds.

The board rejected former Oversight Board member Justin Peterson’s suggestion to use commonwealth financial surpluses for PREPA because the commonwealth didn’t owe the authority money.

Author(s): Robert Slavin

Publication Date: 13 Nov 2023

Publication Site: Fidelity Fixed Income/Bond Buyer

Moody’s cuts D.C. rating outlook to match U.S.; holds steady on Florida, Maryland, Virginia

Mary Pat Campbell

Link: https://fixedincome.fidelity.com/ftgw/fi/FINewsArticle?id=202311131727SM______BNDBUYER_0000018b-c9ff-d00d-ad8b-ebff49580002_110.1

Excerpt:

Moody’s Investors Service (MCO) revised its rating outlook for the Aaa-rated District of Columbia to negative Monday, matching its Friday action on the United States government.

At the same time, the rating agency affirmed the Aaa issuer ratings and stable outlooks of Florida, Maryland and Virginia.

The actions follow Friday’s outlook revision on the United States to negative from stable by Moody’s while it affirmed the U.S. sovereign rating at Aaa.

Moody’s said the main reason for the negative outlook on the United States was its assessment that “the downside risks to the U.S.’ fiscal strength have increased and may no longer be fully offset by the sovereign’s unique credit strengths.

“In the context of higher interest rates, without effective fiscal policy measures to reduce government spending or increase revenues, Moody’s expects that the U.S.’ fiscal deficits will remain very large, significantly weakening debt affordability,” the rating agency said. “Continued political polarization within U.S. Congress raises the risk that successive governments will not be able to reach consensus on a fiscal plan to slow the decline in debt affordability.”

Author(s): Chip Barnett

Publication Date: 13 Nov 2023

Publication Site: Fidelity Fixed Income – Bond Buyer

If Puerto Rico bankruptcy ruling stands, it could devastate municipal borrowing

Mary Pat Campbell

Link: https://www.foxbusiness.com/financials/puerto-rico-bankruptcy-ruling-stands-could-devastate-municipal-borrowing

Excerpt:

In the bankruptcy proceedings of the power utility, Swain sided with borrowers and concluded that special revenue bondholders do not hold a secured claim on current and future net revenues. As The Wall Street Journal explained in March, “A federal judge curbed Puerto Rico bondholders’ rights to the electric revenue generated by its public power utility.”

Furthermore, the ruling stated that the original legal obligation of the borrowers is not the face value of the debt, but rather what the borrower (in this case “PREPA”) can feasibly repay. This ruling raises concerns regarding its broader implications for the municipal bond market. 

Municipal bonds play a pivotal role in financing vital infrastructure projects across America. However, Swain’s decision poses a significant threat to the traditional free-market principles that underpin the structure and security of municipal bonds, particularly special revenue bonds.  

These bonds have provided investors with the assurance of repayment through revenue streams generated by specific projects or utilities. By eroding this sense of security, the ruling fundamentally alters the risk-reward dynamics of municipal bonds, disregarding the principles of free markets and limited-government intervention.  

Consequently, state and local governments may encounter elevated borrowing costs when issuing bonds for necessary public investments, hindering fiscal responsibility and the efficient allocation of resources. 

Author(s): Matthew Whitaker

Publication Date: 5 Sep 2023

Publication Site: Fox Business

Public Pensions: Double-Check Those ‘Shadow Banker’ Investments

Mary Pat Campbell

Link:https://www.governing.com/finance/public-pensions-double-check-those-shadow-banker-investments

Excerpt:

For almost a decade leading up to 2021, bond yields were suppressed by low inflation and central bank stimulus. To make up for scanty interest rates on their bond investments, many public pension funds followed the lead of their consultants and shifted some of their portfolios into private credit funds. These “shadow bankers” have taken market share from traditional lenders, seeking higher interest rates by lending to non-prime borrowers.

Even during the pandemic, this strategy worked pretty well, but now skeptics are warning that a tipping point may be coming if double-digit borrowing costs trigger defaults. It’s time for pension trustees and staff to double-check what’s under the hood.

For the most part, the worst that many will find is some headline risk with private lending funds that underwrite the riskiest loans in this industry. Even for the weakest of those, however, the problem will not likely be as severe as the underwater mortgages that got sliced, diced and rolled up into worthless paper going into the global financial crisis of 2008. And until and unless the economy actually enters a full-blown recession, many of the underwater players will still have time to work out their positions.

The point here is not to sound a false alarm or besmirch the private credit industry. Rather, it’s highlighting what could eventually become soft spots in some pension portfolios in time to avoid doubling down into higher risks and to encourage pre-emptive staff work to demonstrate and document vigilant portfolio oversight.

Author(s):Girard Miller

Publication Date: 8 Aug 2023

Publication Site: Governing

Tweets of the Day on Bonds, Jobs, Leverage, China, Oil, and Artificial Intelligence

Mary Pat Campbell

Link:https://mishtalk.com/economics/tweets-of-the-day-on-bonds-jobs-leverage-china-oil-and-artificial-intelligence/

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Excerpt:

Everyone knows, or at least should know, that the “Big 3” rating agencies that rate about 98 percent of all debt all issue trash ratings. Here’s the background on how that happened.

Rating agencies used to get paid by investors on the basis of how well they did at estimating the likelihood of default. The better your ratings, the more sought out your opinions.

In the mid 1970s, the SEC created nationally recognized statistical ratings organizations (NRSROs). Following that idiotic regulation, the rating agencies got paid on the basis of how much debt they rated, not how accurate their ratings were. Fees come from corporations issuing debt, not investors seeking true default risk.

The more stuff you rate AAA, the more business you get from companies who want their debt rated. The new model is ass backward, and why ratings are trash. A genuine fiasco happened with ratings during the Great Financial Crisis with tons of garbage rated AAA went to zero.

There should not be NRSROs. The SEC made matters much worse, except of course for the Big 3 who have a a captured, mandated audience, coupled with massive conflicts of interest.

Author(s): Mike Shedlock

Publication Date: 5 Aug 2023

Publication Site: Mish Talk

Fitch Downgrades U.S. Credit Rating

Mary Pat Campbell

Link: https://www.wsj.com/articles/fitch-downgrades-u-s-credit-rating-56c73b89?mod=hp_lead_pos1

Excerpt:

Fitch Ratings downgraded the U.S. government’s credit rating weeks after President Biden and congressional Republicans came to the brink of a historic default, warning about the growing debt burden and political dysfunction in Washington.

The downgrade, the first by a major ratings firm in more than a decade, is evidence that increasingly frequent political skirmishes over the U.S. government’s finances are clouding the outlook for the $25 trillion global market for Treasurys. Fitch’s rating on the U.S. now stands at “AA+”, or one notch below the top “AAA” grade.

….

Few investors believe that Fitch’s downgrade will immediately challenge that role. Still, it is the first time a ratings firm lowered its headline assessment of the U.S. government’s propensity to pay its bills on time since Standard & Poor’s in 2011 lowered its rating one notch below the top grade. That decision followed another tense debt-ceiling standoff in Congress.

Moody’s, the other member of the three big U.S. ratings firms, continues to give the U.S. its strongest assessment.

Fitch said Tuesday that the downgrade reflects an “erosion of governance” in the U.S. relative to other top-tier economies over the last two decades.

“The repeated debt-limit political standoffs and last-minute resolutions have eroded confidence in fiscal management,” Fitch said.

Author(s): Matt Grossman and Andrew Duehren

Publication Date: 1 Aug 2023

Publication Site: WSJ

Canadian legislation aimed at protecting pension plans may mean significant changes for lenders, borrowers and employees

Mary Pat Campbell

Link: https://www.nortonrosefulbright.com/en-us/knowledge/publications/e91814ee/canadian-legislation-aimed-at-protecting-pension-plans-may-mean-significant-changes

Excerpt:

On February 3, 2022, Bill C-228 was introduced as a private members bill and has now made its way to the third reading in Canada’s Senate. The purpose of Bill C-228 is to greatly expand the pension liabilities that are afforded super priority status by amending bankruptcy and insolvency legislation. As currently drafted, the Bill will grant priority for a pension plan’s unfunded liability or solvency deficiency claims over the claims of the majority of creditors — including secured creditors — unless specifically enumerated otherwise in the statutes.

The “unfunded liability” is the amount necessary to enable the fund to continuously pay member benefits as they come due, on the assumption that the fund will operate for an indefinite period of time. The “solvency deficiency” includes the amount necessary to ensure the fund meets its obligations if wound up. As these amounts are constantly fluctuating, a fixed value cannot be ascribed to either of these requirements other than through a single point in time calculation by an actuary.

What does this mean for borrowers with pension plans?

Clearly, Bill C-228 would substantially increase the opportunity for recovery of pension entitlements within insolvency proceedings by way of super priority. The issue is whether it remains viable for lenders to provide capital to borrowers with defined benefit pension plans given the increased risk profile that may be created by Bill C-228 expanding the pension claims that take priority over a secured creditor in an insolvency case.

In all likelihood, Bill C-228 will minimally effect borrowers that have defined-contribution pension plans as the employer’s liability is restricted to predefined contributions. As this type of plan is subject only to ordinary course known contribution requirements, and given that the employer does not guarantee a certain amount of income in retirement, the liability afforded super priority in insolvency proceedings should be predictable in most circumstances.

Conversely, Bill C-228 will significantly impact defined-benefit pension plans. These types of plans commit to providing a specified level of income in retirement based on a variety of factors. As such, an employer must diligently manage the pension fund to ensure it is in a position to pay the benefit to the employee for the remainder of their life, once retired. The inherent challenge with these plans is the uncertainty of the liability of the employer at any given time and the potentially large scope of that liability based in part on external factors such as interest rate fluctuations.

Bill C-228 has therefore created a conundrum. Although the intention of the Bill is to protect pension plans, it may potentially cause a shift that results in even more employers moving from a defined-benefit pension plan to a defined-contribution pension plan. Plainly, this shift may be caused by lenders’ concerns regarding the uncertainty surrounding the amount necessary to liquidate an unfunded liability or solvency deficiency at any given time. In other words, a lender will not be able to determine prior to the lending decision, with any great certainty, the amount of the unfunded liability or solvency deficiency in a future insolvency proceeding. At a minimum, a secured creditor wants to know the quantum of obligations that will take priority over their interests. This is essential information in deciding the quantum of a loan, the terms of such loan, any reserves and whether the creditor will agree to loan any money to the borrower.

Author(s): Candace Formosa

Publication Date: 2023Q2

Publication Site: Norton Rose Fulbright

NYC pension funds lose $2M in failed First Republic, Signature banks

Mary Pat Campbell

Link: https://nypost.com/2023/05/20/nyc-pension-funds-lose-2m-in-first-republic-signature-banks/

Excerpt:

City pension funds had almost $2 million invested with First Republic and Signature banks — losing it all when both banks failed this year.

The losses were contained in new data The Post obtained from the city Comptroller’s office under a Freedom of Information Law request.

Though a federal bailout rescued bank depositors, the city’s pension cash had been invested in bank stocks and bonds.

“The overall loss is negligible in the context of the daily market motions of our $240 billion pension funds,” said Chloe Chik, spokesperson for Comptroller Brad Lander.

All five city pensions funds were hit in the bank failures.

Author(s): Jon Levine

Publication Date: 20 May 2023

Publication Site: NY Post

Statement of CFPB Director Rohit Chopra, Member, FDIC Board of Directors, on the Proposed Special Deposit Insurance Assessment on Large Banks

Mary Pat Campbell

Link: https://www.consumerfinance.gov/about-us/newsroom/statement-of-cfpb-director-rohit-chopra-member-fdic-board-of-directors-on-the-proposed-special-deposit-insurance-assessment-on-large-banks/

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Excerpt:

First, we need to simplify our rules while strengthening them. Too many areas of regulation across our economy have become so complicated with weird formulas, dizzying methodologies, and endless loopholes and carveouts. We need simpler rules to prevent future disasters. A better alternative is to create bright line limits, with clear sanctions, including size caps and growth restrictions. Clearly observable metrics make it easier to monitor and increase consistency.

Second, we need to stop subsidizing the largest and riskiest banks by giving out free deposit insurance. When small banks fail, they rarely lead to much cost to the FDIC’s Deposit Insurance Fund, since they can be fairly easily wound down or sold. But when large banks fail, the costs to the Deposit Insurance Fund and broader economy can be steep. To make matters worse, those institutional clients with the biggest deposits feel they can get around insurance limits by going to the biggest banks. In other words, people perceive that the biggest banks get free deposit insurance over the legal limits by way of their too-big-to-fail status.

Fixing our deposit insurance pricing structure is just one small step that could help address this problem. Large, riskier banks should pay more and small, simpler banks should pay less. We should also make the framework countercyclical, so that we aren’t in the position of raising rates when banking conditions are weak.

While today’s proposed special assessment will not fall on small, local banks, the failure of First Republic Bank will be a direct hit to the Deposit Insurance Fund that is not being recouped through this special assessment. It’s a reminder that we need to fix the fund’s pricing over the long term.

Finally, as Swiss policymakers made clear regarding the recent turmoil involving Credit Suisse, more people are saying the quiet part out loud: the current resolution plans filed by the largest financial institutions in the world, which purport to show how the firms could fail without a government bailout or economic chaos, are essentially a fairy tale.5

The latest failures are another reminder that we must work to eliminate the unfair advantages bestowed upon too-big-to-fail banks. New laws and old laws alike provide a roadmap to end too-big-to-fail and the resulting risks to financial stability, fair competition, and the rule of law.6

Author(s): Rohit Chopra

Publication Date: 11 May 2023

Publication Site: Consumer Finance Protection Bureau

The New Mortgage Fee Structure

Mary Pat Campbell

Link: https://rajivsethi.substack.com/p/the-new-mortgage-fee-structure

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Excerpt:

Notice that credit scores below 639 have been consolidated into a single row, and those above 740 have been split into three. In addition, loan-to-value ratios at 60% and below are now in two separate columns rather than one. This makes direct visual comparisons a little difficult, but one thing is clear—at no level of the loan-to-value ratio does someone with a lower credit score pay less than someone with a higher score. That is, one cannot gain by sabotaging one’s own credit rating.

In general, there are two types of borrowers who stand to gain under the new fee structure: those with low credit scores, and those with low down payments. In fact, those at the top of the credit score distribution gain under the new structure if they have down payments less than 5% of the value of the home. The following table shows gains and losses relative to the old structure, with reduced fees in green and elevated ones in red (a comparable color-coded chart with somewhat different cells may be found here):

What might the rationale be for rewarding those making especially low down payments? Perhaps the goal is to make housing more affordable for people without substantial accumulated savings or inherited wealth. But there will be an unintended consequence as those with reasonably high credit scores and substantial wealth choose to lower their down payments strategically in order to benefit from lower fees. They may do so by simply borrowing more for any given property, or buying more expensive properties relative to their accumulated savings. The incentive to do so will be strongest for those hit hardest by the changes, with credit scores in the 720-760 range and down payments between 15% and 20%.

Author(s): Rajiv Sethi

Publication Date: 23 Apr 2023

Publication Site: Imperfect Information at Substack

Debt ceiling fears push the cost of insuring against a US government default to highest level since 2008 crash

Mary Pat Campbell

Link: https://finance.yahoo.com/news/debt-ceiling-fears-push-cost-184617316.html

Excerpt:

The cost of insurance against the US failing to repay its debts rose to its highest level since the financial crisis last week, as traders worried that political deadlock in Washington might lead to a default.

One-year government credit default swaps traded at 106 basis points Saturday – the most expensive they’ve been since 2008, according to a Financial Times report that cited Bloomberg data.

Credit default swaps – or CDSs – are a form of insurance against a borrower not making scheduled payments on their debt.

The price of one-year government CDSs has spiked 15 basis points in 2023 with traders spooked by the looming threat of a debt-ceiling crisis, the FT reported.

The debt ceiling is a limit on how much the government can borrow, set by Congress. The US hit its $31.4 trillion debt limit in January – and that means it could run out of money to pay its bills as soon as July if lawmakers don’t vote to raise the ceiling, according to the Congressional Budget Office.

Author(s): George Glover

Publication Date: 24 Apr 2023

Publication Site: Yahoo Finance