In this blog we step back to look at the broader context around two separate news stories that have been in the muni bonds spotlight in one form or another this year: Illinois and Puerto Rico.
Does it Matter? Of Illinois, Chicago, Pensions, and Other Fiscal Woes across the Prairie State
Much has been made about the relatively poor fiscal health of Illinois, but what of Chicago, America's third largest city, and economic engine of the state? To recap, back in March1 the Land of Lincoln's credit rating - already the lowest of any state in the country - appeared in serious danger of another downgrade, with the government in Springfield having failed to pass a budget for two years, or seriously address its chronically underfunded pension system, the liabilities of which ran to an eye-popping 450% of annual revenue.2 Even after the state legislature finally passed a "balanced" budget on July 6th - Republicans joined with Democrats to override Governor Rauner's veto by hiking income taxes by approximately 32%, many agree Illinois's budgetary woes are far from over.3 But does Chicago's fiscal health mirror Illinois'?
On the surface, the answer is "Yes;" if anything, Chicago's in even worse financial shape. In July, Moody's confirmed4 Illinois' general obligation (GO) bonds rating of Baa3, the lowest "investment grade" rating, but Chicago's GO bonds are rated a notch below5 even that: Ba1, in speculative territory. Similar to its home state, Chicago recently raised taxes with the goal of balancing its budget and accelerating pension funding, but the city's pension liabilities are so out of control that Moody's deemed even this step "insufficient to arrest growth" in the city's liabilities.
All of this may be true, and yet any casual visitor to Chicago these days could hardly avoid noticing the dozens of construction cranes6 towering all over the city, which would appear to belie the gloomy economic picture the preceding paragraphs may have painted. In fact, as of September 29th, there were 33 active tower cranes throughout the city, and 54 tower cranes have been used in high-rise projects throughout 2017, surpassing the city's post-recession record (set in 2016) for active cranes in a year. In the hopes of wooing Amazon to choose Chicago for its HQ2, the city also recently took the wraps off what could become a 100 acre lakefront redevelopment megaproject,7 built-to-suit for the tech giant.
All of this visible construction points to something all-but-invisible to the naked eye: a robust economy and strong economic growth, in spite of the difficulties city and state government may have in balancing their budgets.
Chicago skeptics may point to the area's population loss as an indicator of a mixed economic bag, but as with the city's credit rating, numbers can be deceptive. Although it's undeniable that Cook County - the second-largest county in the United States and home to Chicago and many of its suburbs - has been making headlines for historic population declines,8 the story on the ground is a bit more nuanced:9 many residents are moving out of high-poverty neighborhoods, while affluent neighborhoods have seen rising populations.
Puerto Rico and Elon Musk
Puerto Rico was already in deep financial trouble this year after it defaulted,10 in the summer of 2016, on its constitutionally guaranteed general obligation bonds. And that was before Hurricane Maria, a Category 5 storm, ripped through the island, destroying infrastructure, flooding streets, and leaving many of the three million American citizens in dire straits without electricity or access to clean water.
Puerto Rico's electrical grid is in particularly bad shape after the hurricane, and was already in a downward spiral11 of high electricity costs and poor service before the storm hit. Part of this is attributable to the difficulties of maintaining an electrical grid on a tropical island, where salt in the air corrodes equipment, forests grow quickly and must be constantly cut away from power lines, and forbidding geography makes road access to electrical infrastructure problematic. The hurricane pretty much destroyed this already vulnerable system, and the consequences are clear: as of October 17, four out of five Puerto Ricans are still without power.12
Enter billionaire entrepreneur Elon Musk. The founder of PayPal (PYPL), SpaceX, and Tesla (TSLA) announced that he would be willing to help Puerto Rico rebuild its energy infrastructure with the help of Tesla Powerwall battery packs. He appears already to be making good on his pledge, as the packs were spotted a few days ago13 at San Juan Airport.
Can Tesla really make good on Musk's ambitious goal of rebuilding the island's power infrastructure? It's still early days, but the company has some experience in this matter already. In Kauai, the westernmost Hawaiian island, Tesla installed a 55,000 panel solar farm mated to 272 Powerpacks,14 capable of storing a total of 52 megawatt-hours of power. The new installation now allows the island to utilize stored solar power at night, and boosts its renewable power generation to 44% of the total. Tesla also recently won a bid - beating out 91 competitors - to create a 100 megawatt lithium-ion wind power storage facility15 in South Australia, the highest capacity battery of its kind ever produced.
Impressive though these achievements are, they pale in comparison to the challenge Tesla faces if the company is serious about rebuilding Puerto Rico's electrical grid. While Kauai is an island of 70,000 inhabitants, Puerto Rico's population stood at 3.4 million16 as of 2016. That's a lot of batteries, to say the least.
How Musk's ambitious gambit might affect bondholders remains to be seen, depending on how or if he works with the Puerto Rico Electric Power Authority ("Prepa"). Prepa's bonds tumbled after Maria made landfall17with creditors worried they may recover even less through the bankruptcy process than was first thought. If Musk works with the beleaguered utility, which has already been offered a $1 billion lifeline by a group of private investors, bondholders may be more likely to recover some of their initial investments. If Musk and Tesla go it alone and succeed at effectively setting up a parallel, privatized electrical supply system for the island, the bonds may very well remain severely distressed as bankruptcy proceedings continue, but the outcome appears murky at best even at this very early stage.
Facts and fantasy aside, the "possible" silver lining, which was not thinkable or possible prior to the hurricanes, suggests that Puerto Rico might be viewed as a fertile ground for technological innovation and demonstration - à la Musk. I see this as achievable through a Congressional initiative to create a long-term plan for the Commonwealth, to meet need with opportunity, and take Puerto Rico and its citizens into the 21st century.
1Muni Nation: Something is Rotten in the State of Illinois, March 30, 2017
2Municipals Weekly - Bank of America Merrill Lynch: A watershed week for munis, 29 September, 2017
3Politifact: Rauner's right: Illinois budget balancing act an ongoing production, September 20, 2017
4Moody's: Rating Action: Moody's confirms Illinois' Baa3 GO and related ratings, affecting $32 billion of debt; outlook negative, July 20, 2017
5Moody's: Rating Action: Moody's Confirms Chicago, IL's GO at Ba1; Outlook Negative, September 5, 2017
6Curbed: The Chicago skyline is littered with dozens of tower cranes, September 29, 2017
7Curbed: Chicago's plan to attract Amazon to the old Michael Reese Hospital site breaks cover, October 16, 2017
8dna info: Cook County Lost More People Last Year Than Any Other County In The U.S., March 23, 2017
9dna info: As High-Poverty Neighborhoods Shrink, Downtown Construction Booms, March 27, 2017
10Muni Nation: Municipal Defaults, While Rare, Do Occur, April 25, 2017
11FiveThirtyEight: Why Puerto Rico's Electric Grid Stood No Chance Against Maria, October 16, 2017
12BusinessInsider: 4 out of 5 Puerto Ricans are still without power - but darkness is far from the island's biggest problem, October 17, 2017
13Newsweek: In Puerto Rico, Tesla is doing what Donald Trump isn't - fixing it, October 16, 2017
14Curbed: Tesla solar panels and storage will help Hawaiian island go fossil-free, March 10, 2017
15The Verge: Tesla wins bid to build world's largest lithium-ion battery for South Australia, July 7, 2017
16U.S. Census Bureau
17Financial Times: Puerto Rico creditors jockey for position in Hurricane Maria aftermath, September 27, 2017
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