Wednesday, November 22, 2017

Let’s Avoid Total Annihilation

By on March 24, 2017

Miguel Ferrer, chairman Ferrer Faass & Co

Caribbean Business Publisher Miguel A. Ferrer

The Fiscal Plan proposed by the administration of Gov. Ricardo Rosselló and approved by the Financial Oversight & Management Board unfortunately includes a powerful time bomb that can cause devastating effects on Puerto Rico’s society and economy.

The plan was elaborated by deducting “essential” services from the $19 billion in revenues available to the government, leaving the remainder for debt service. The debt service was deemed a nonessential item.

The point of this op-ed piece is to dispute that strategy and propose that Puerto Rico bondholders also be treated as an essential item in the fiscal process.

I applaud the need for the fiscal plan to “embark on a transformative journey in order to provide core services to citizens in an efficient and fiscally responsible manner,” as was presented by the Rosselló administration. Structuring a balanced fiscal plan in the short period requested is in itself a welcomed accomplishment. In the dire straits the government finds itself, I am ready to heed the call for “sacrifice.” Not expected was that bondholders in Puerto Rico are to take the brunt of the blow. In one sweeping motion, the plan wipes away $11.4 billion of their capital.

Few people realize what bondholders are experiencing. The debt service for 2017 is $3.3 billion, yet the fiscal plan provides $818 million for debt service this year. In 2018, the amount is halved to $404 million for a debt service of $3.8 billion. Therefore, during the first year, bondholders receive a 75% cut, and the second year shows cuts of 89%. Over 10 years, proposed cuts equal 76%. No other group or sector is required to assume such sacrifice.

The 60,000 bondholders in Puerto Rico who still have bond investments of $15 billion, in one crushing moment stand to lose $11.4 billion of their capital. Add to this blow the hardships of losing about $685 million in annual interest payments, $6.85 billion over 10 years, and we realize the immensity of this financial wipeout. There is no equivalent for that kind of monetary loss in Puerto Rican history. This severe blow will cause massive disruption in our society and cripple our economy.

The Puerto Rico “ahorristas” are as vulnerable a group, and as essential an item as those included in the “protected costs” of the fiscal plan. They must be afforded that same financial consideration—not monetary annihilation.

Let’s put a face on it. Take doña Pancha, an 80-year-old retired clerk, who worked 45 years and saved $100,000 to complement her social security. As many others, she invested her savings in Puerto Rico bonds. For years, she received interest income of $6,000, or $500 a month. This plan blows away $76,000 of her $100,000 investment. Her principal would be reduced to $24,000, her interest income (at 6%) would drop to $1,440 per year, or just $120 a month. She cannot pay her utilities with that amount, let alone purchase medication. Doña Pancha, an imaginary example based on a construct of real cases, not only will lose $76,000 of her investment but also $45,600 of income during the next 10 years.Doña Pancha faces a miserable future. Again, no other group is being required to sacrifice so much—not the government apparatus, not the University of P.R., not the pensioners and, certainly, not the government employees.

(Juan J. Rodríguez / CB)

(Juan J. Rodríguez / CB)

For the 60,000 Puerto Rican bondholders affected by these Draconian cuts, it can get worse. The cuts to bondholders are of such magnitude that I do not foresee a successful negotiation. Instead, I expect the powerful investor groups will fight to the bitter end in court. These are the large institutional fund managers and hedge funds. General-obligation (GO) bondholders with their Constitutional protections and Cofina (Sales Tax Financing Corp.) bondholders with their securitization guarantees have solid legal ground on which to stand. With only $800 million for debt service, the likely scenario is that it will probably all be paid to GO and Cofina bondholders, with nothing left for the other lesser credits, which comprise the majority of local holdings. Puerto Rican bondholders will be at the bottom of the pile. Most likely they may not even get 24¢ on the dollar. They may lose all their investment, which for most local bondholders is the equivalent of their life savings, and they will be left with no investment income.

Aside from the devastating effect these cuts will have on local bondholders and the economy, an unintended consequence is that it will forever eliminate the possibility of a local capital market for Puerto Rico bonds. For years, the local market provided funding for many a crucial project as well as for sustaining our government structures.

The size of these cuts also will damage our capacity to return to the U.S. bond market. Without access to capital, the possibility of building and rebuilding our infrastructure and economy will be severely limited.

There is talk about the possibility that through legislation local bondholders will be offered tax credits to recover part of these huge capital losses, but nothing to recover lost income. I acknowledge this effort from the Rosselló administration as a positive step to address the disaster facing Puerto Rico’s “ahorristas,” but consider it totally inadequate to attend to the magnitude of the financial wound.

Most people understand we need to address our fiscal crisis as soon as possible, in realistic terms. However, we must distribute the pain more evenly before we do lasting harm to our people, our society and our economy. As I have said before, let’s avoid destroying the economy to save the government. We certainly must not entertain the notion of the total annihilation of our local capital base.

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