Sunday, March 18, 2018

Person of the Year: The Debt Monster

By on December 17, 2015

Puerto Rico Debt Crisis Shrouds Washington, D.C. in controversy


Few stories pertaining to Puerto Rico have captured the attention of mainstream press as the island’s debt—a monster towering $70 billion tall. It loomed large on the horizon long before 2015, but Puerto Rico managed to keep it at bay in 2014 with a $3.5 billion deal put together by the Royal Bank of Canada, Barclays and Morgan Stanley. The bond deal gave Puerto Rico’s government much-needed liquidity at a 10% yield no less because the island’s credit had been downgraded to noninvestment grade, or junk, in February 2014, just over a year into Gov. Alejandro García Padilla’s first term as governor.

No sooner had the bond deal been struck when the García Padilla administration’s economic team was seen slapping high fives, their jubilation a sign that Puerto Rico had obtained essential financing, but at a high cost. At the same time, the deal would continue to mask a devastatingly low labor-force participation rate stuck at 40%, outmigration of Puerto Rico’s professional class and young adults to the tune of 1,000 people jetting from the island every week and an economy stuck in a nine-year funk. This was a year ago when Puerto Rico still had access to capital markets—albeit barely—and the García Padilla administration’s restructuring brigades could delude themselves into believing the debt behemoth could somehow be kept under control.

This was a fleeting moment of self-deception because deep down, everyone knew there was a horrendous debt-service payment schedule looming on the horizon—this year alone, there was a $415 million payment due for the Puerto Rico Electric Power Authority (Prepa), $1 billion due for general-obligation bonds and $300 million in tax revenue anticipation notes—all in just one month, July. Other hundreds of millions of dollars were due throughout the year, including a $354.7 million payment on outstanding GDB notes on Dec. 1.

It was becoming increasingly clear that without economic development and with a paper-thin tax base, Puerto Rico’s government faced the impossible task of fighting Godzilla with rubber bullets.

However, it took a June 2015 report, “Puerto Rico—A Way Forward,” painstakingly put together by former International Monetary Fund Managing Director Anne Krueger (she pronounces it Kreeger) and colleagues Ranjit Teja and Andrew Wolfe, to open the governor’s eyes to the magnitude of the crisis. In Krueger’s perspective, Puerto Rico, despite the commonwealth having implemented rather hefty spending cuts and tax increases that levied more than $2 billion in taxes on taxpayers and the business community, continues hemorrhaging jobs and therefore, lacks the revenue stream to meet enormous debt-service payments over the next 20 years. The island’s debt-service payments will total more than $5 billion in fiscal 2016 alone, according to the Government Development Bank (GDB). This is an impossible debt burden for an economy that is now in a nearly 10-year freefall, during which time more than 12,000 businesses have closed and more than 225,000 jobs have been lost.


Krueger’s report came to the inevitable conclusion that it was impossible to grow Puerto Rico’s economy without restructuring its $70 billion public-sector debt. During an exclusive interview with Caribbean Business that took place one week after the iron maiden delivered her devastating report, Krueger insisted that labor reforms and economic development were essential components missing from a formula for sustainable growth.

Krueger told Caribbean Business that labor reforms— such as extending the probationary period for new hires from three months to one year, cutting excessive overtime costs and slashing paid vacation from 30 days down to 15 days—were essential to create jobs and get the economy growing again, just as it was important to have the recourse of orderly restructuring of the insurmountable debt. “It would certainly make it a smoother process; let me put it that way. There is going to come a point where it has to happen somehow,” Krueger told Caribbean Business. “And with Chapter 9 [bankruptcy], it might come a little sooner and that would be a little less costly for Puerto Rico. So, yes, it would make it easier…there will come a time when Puerto Rico can’t pay,” she said at the time.

That was more than five months ago. In the time since delivering the report, Krueger headlined a dog and pony show in July with Jim Millstein, a former U.S. Treasury Chief Restructuring Officer hired by the Puerto Rico government to help in the restructuring eff orts, before an audience of a select group of creditors that characterized the meeting as a one-sided pitch rather than the beginning of true negotiations. Few people were impressed. “That wasn’t a conversation. That was just a presentation of the Krueger report. There was no dialogue,” said Ambac Assurance CEO Nader Tavakoli during an exclusive interview with Caribbean Business days after the dog and pony show with creditors. “We need real dialogue—people sitting down at the table and discussing real solutions, including liquidity solutions. There is a real liquidity problem—the liquidity problem shouldn’t be used as an excuse for default,” he said.

Back then, the administration was hoping it could obtain orderly relief through the Puerto Rico Debt Compliance & Recovery Act of 2014—also known as the local bankruptcy law—or through U.S. House Resolution 870, which was filed by Puerto Rico’s nonvoting member of Congress, Resident Commissioner Pedro Pierluisi, to amend Chapter 9 of the U.S. Bankruptcy Code to include Puerto Rico.

Conventional wisdom on the reasoning behind removing Puerto Rico and the other territories from the bankruptcy protections of Chapter 9 in 1984 has led the public to believe this was an act by Congress that took place much as penicillin was discovered—by accident. “Nothing in Congress happens by accident,” explained one lobbyist on Capitol Hill who chose to remain anonymous. “Members of Congress were lobbied and someone stood to benefit from that. Ask yourself who that someone may be and I think you will find creditors behind it.”


As 2015 winds to a close, the possibility of Congress passing a bill to amend Chapter 9 to extend protections to Puerto Rico seems highly unlikely. “The problem is that the García Padilla administration has been going about this all wrong because they are only lobbying members of Congress,” said another source on Capitol Hill with close ties to the Democratic Party, who talked to this newspaper in June. “The bondholders have also been lobbying members of Congress. So, you have two forces canceling each other out. What Puerto Rico needs is to lobby the bondholders so they can understand the importance of orderly debt restructuring for Puerto Rico.”

The most recent lobbying eff ort by the García Padilla administration took place this past week. An army of public officials—from heads of the island’s mayors associations to the University of Puerto Rico president—descended on Capitol Hill for what amounted to lightning photo-op meetings coordinated by public relations firm SKDKnickerbocker. Meanwhile, the so-called “de facto” governors of Puerto Rico—namely advisers on the level of Millstein and retired U.S. Bankruptcy Judge Steven Rhodes, who oversaw Detroit’s bankruptcy case, and Dick Ravitch, former lieutenant governor of New York, wielded their brand of statecraft in meetings to help secure a bill to tackle Puerto Rico’s fiscal crisis, which was filed jointly by U.S. Republican Sens. Orrin Hatch (Utah), Lisa Murkowski(Alaska) and Charles Grassley (Iowa).

The measure, dubbed the Puerto Rico Assistance Act, would provide short-term tax relief to the island’s workers, while tapping into Affordable Care Act funds to make available to the commonwealth government up to $3 billion in bridge financing through fiscal year 2016.

In return, the Republicans are proposing the creation of the “Financial Responsibility & Management Assistance Authority”—a U.S. president-appointed, six-member entity to control the commonwealth’s budgetary and fiscal processes, among other tasks. The authority would be vested with broad investigative powers, including direct access to the commonwealth’s information systems, documents or data. It would be allowed to issue subpoenas, and may seek judicial enforcement to carry out its responsibilities under the legislation.

Congress would be kept very much in the loop, with the proposed entity having to constantly report back to Capitol Hill on several matters, including the commonwealth’s progress in meeting—or failing with— the bill’s objectives, as well as any action that may adversely affect “the commonwealth’s best interests.”

In a recent interview with the investigative magazine Mother Jones, Pierluisi said the bill introduced by Hatch imposes a federally appointed board that would have “total control” over financial decision- making in Puerto Rico.

Some observers see the filing as the ultimate act of cynicism because they see a categorical impediment to its passing in the U.S. House of Representatives, where a block of 40 votes of the Tea Party persuasion refuse to consider any measure that even remotely resembles a bailout for the island.


To say that Puerto Rico’s $70 billion debt monster is complicated is an understatement.

The debt structure comprises 18 government entities and instrumentalities, including the commonwealth government, GDB and a host of public corporations—but excluding municipal governments— with eight levels of protection to bondholders, from the most secure to the weakest, according to Sergio Marxuach, the policy director for the Center for a New Economy, a San Juan-based think tank.

The bonds that off er the most protection are general-obligation (GO) bonds, which are backed by the full faith and credit of the commonwealth government. According to the Puerto Rico Constitution, paying GO bonds has a “first claim on the available resources of the Commonwealth,” as Marxuach notes in a November 2015 analysis of the island’s debt structure.

Second in line are bonds and notes guaranteed by the commonwealth’s good faith and credit and include some bonds from the Puerto Rico Aqueduct & Sewer, Public Buildings and Puerto Rico Infrastructure & Financing authorities, among others.

Third are bonds issued by the Sales Tax Financing Corp., known as Cofina by its Spanish acronym, which are secured by 3.5% of the 11.5% sales & use tax.

Fourth in line are bonds issued by the Municipal Finance Agency, followed by those issued from the “state-owned enterprises,” or public corporations, which are expressly guaranteed by the commonwealth.

Then there is debt known as commonwealth appropriations or taxes, which require legislative assignments for repayment. These debts include those from the Public Finance Corp., of which the Puerto Rico government already defaulted in August 2015.

Seventh in line, and near the bottom of the list, are employees retirement system bonds, which are solely paid by employer contributions and aren’t guaranteed by the commonwealth.

Finally, the last in line and the weakest are limited obligation and “nonrecourse debts,” which include bonds issued by the Children’s Trust, as well as some from the Housing Finance Authority and Puerto Rico Highways & Transportation Authority.

Unless Puerto Rico is granted access to Chapter 9, Marxuach has predicted a battle royale between the commonwealth and its many creditors because of the complex debt structure.

He concurs with an assessment of Puerto Rico’s debt structure by Anna Gelpern of the Peterson Institute for International Economics. “The insanely convoluted debt structure includes bonds whose priority repayment is guaranteed by the Puerto Rican Constitution, bonds governed by New York law, bonds secured by sales-tax revenue routed to the creditors by statute, bonds secured by other revenue pledges that could be more easily diverted and bonds payable if the Legislature appropriates the money. There are also pensions and other government obligations to its citizens, which have their own constituencies and protections,” she said in an October 2015 article.

For Marxuach, the “end game” must include granting Puerto Rico access to Chapter 9. “First, bankruptcy protection is not a federal bailout, as it would not cost the federal government a single cent. Furthermore, it could be argued that the probability of a bailout by the federal government would increase significantly if Puerto Rico and its agencies and instrumentalities were not allowed to restructure their debt under Chapter 9,” he said in his analysis.

“Second…Puerto Rico’s debt is spread across a variety of debtors [18 issuers in total] representing a complex web of claims in an uncertain regulatory and legal framework. This situation makes it very difficult for creditors to work as a class because one set of creditors will worry that any relief they provide the island will simply make it easier for a different set of creditors to recover a larger amount of their claims,” he added.


Today, the García Padilla administration is in a life or death struggle attempting to close a restructuring support agreement (RSA) with creditors that own Prepa debt. In what has amounted to a complex game of cat and mouse, Prepa Chief Restructuring Officer Lisa Donahue has negotiated extension upon extension of a forbearance agreement that is on its last legs. At this writing, there is a Dec. 17 deadline approaching on the RSA that will likely be extended once again. A key sticking point is putting together a deal that would allow MBIA Inc.’s National Public Finance Guarantee, one of the bond insurance companies on the hook for a whopping $1.4 billion in Prepa debt, to guarantee a refinancing of some of its debt. This way, outright default is averted; but the blue chippers in the financial community remain very cautious about Puerto Rico.

All observers are pointing to this negotiation as essential because it would provide a blueprint for the shape of restructuring to come.

The alternative—default— would send Puerto Rico down a path of no return with litigation that some creditors have estimated will cost the government some $500 million annually and loss of access to capital markets for more than a decade. Marxuach, Krueger and others see Chapter 9 as the answer, however imperfect it may be, with some pointing out that Detroit has bounced back from the brink.

Regardless, no one wants a bleak future for Puerto Rico, and it remains to be seen what the New Year will bring. 

—Reporter Luis J. Valentín contributed to this story.


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