GDB in Peril, Weighs Options in Face of Insolvency
By Luis J. Valentín & Philipe Schoene Roura
In the epic drama building over Puerto Rico’s debt crisis, many government entities play huge parts, yet few more critical than the Government Development Bank (GDB).
The island’s fiscal agent would pay some $9 million in interest payments on April 1, but come the following month, it faces a potential meltdown of apocalyptic proportions when roughly $422 million is due on May 2. The bank owes about $4 billion to its creditors.
The combination of fast-dwindling cash reserves and no timely debt-relief action could land a mortal blow to the GDB’s operations, with ripple effects on the Puerto Rico government and economy. But what exactly does it mean to have the bank even in a partial shutdown? What is the commonwealth government exactly willing to do about this?
La Fortaleza says it is waiting for Congress to deliver favorable legislation to deal with the island’s fiscal crisis. Yet some observers have likened the latter to Samuel Beckett’s “Waiting for Godot” and believe the bank would be pressed to siphon through its available cash to meet at least part of what it owes in May, barring some sort of last-minute funding maneuver that could prevent it from falling off the cliff and avoid creditor lawsuits.
Late Wednesday, the bank announced it has reengaged in conversations with a large group of its creditors over the possibility of restructuring the bank’s debt, while adding it continues to evaluate “all legal options available” to tackle its fiscal woes.
Several sources confirmed to Caribbean Business that the Alejandro García Padilla administration is already moving forward on several options that would not only address the bank’s debt situation, but also that of the rest of the commonwealth.
One such measure would seek a moratorium on payments while the GDB works things out, imposing “an FDIC-like [Federal Deposit Insurance Corp.] approach to the resolution of the situation, with the bank to protect depositors and access to its asset value, while figuring out some restructuring of the third-party creditor debt,” said one government source with knowledge of the matter. “Traditionally, the FDIC does a good bank/bad bank act, moving assets and deposits into a good bank, then leaving behind the third-party debt.”
But in the island’s Legislature, politicians continue at odds over how best to deal with the issue. In fact, they have been at it for months, and among the measures that have been discussed is the good bank/bad bank approach, as well as other ideas to provide some sort of short-term relief to the bank through local legislation, at least two sources said.
But rather than keeping the GDB on life support, some lawmakers have been pushing for months to do away with the bank once and for all. There is once again a movement afoot to revive the idea of parting ways with the institution, say several sources.
Meanwhile, the GDB could already be in noncompliance with required liquidity reserves. A recent federal court ruling states that the island’s commissioner of financial institutions has found the bank to be already insolvent, and a request to the Puerto Rico Treasury secretary for a three-month waiver to meet required reserves could be in the pipeline. Back in December, the bank’s board authorized management to ask for the waiver if needed.
The institution continues to scramble for ways to ensure the continuation of its day-to-day operations and, in turn, avoid what could turn out to be a devastating domino effect on the rest of the commonwealth. Behind the scenes, the GDB is also waging a war to preserve confidence in its continuation—while avoiding a run on the bank—which could prove to be a more daunting task amid all the noise and suspicions over its fiscal health.
A veil of doubt
So far, most government officials have come forward in support of the GDB, recognizing the need to ensure its stability. The García Padilla administration has stated it could seek to amend the bank’s charter law, if necessary, to enforce a moratorium on the payment of GDB debt. However, La Fortaleza has said it continues to wait for congressional action before pulling the trigger.
While legislation to deal with the bank’s immediate future could be filed soon, sources have told this newspaper that some high-ranking Puerto Rico lawmakers remain highly skeptical about providing short-term relief to the GDB, and are rather looking into ways to get rid of it, while creating a similar entity with a clean slate.
“There have been conversations on and off regarding how to help protect the institution and to have a mechanism to deal with its debt,” said one government source who chose to remain nameless. “How much of a chance this has of flying? We don’t know.”
Sources have said that the splintering of the GDB into good/bad entities may be one avenue gaining momentum to deal with its impending fiscal challenges. “Or the creditors could petition for the appointment of a receiver, and the bank can be liquidated,” another government source said.
Meanwhile, the bank has been seeking to stave off requests from some government entities that have expressed their wish to take their deposits out of the institution, a development that would further drain the bank’s liquidity position, two sources recently told Caribbean Business.
Last year, a legal feud between the Municipal Revenue Collections Center (CRIM by its Spanish acronym) and the GDB over the deposit of certain municipal funds provided a glimpse of the deep concerns many government players have over the possibility of the bank facing receivership.
The bank’s main sources of funding comprise public-sector deposits, senior debt issued by the GDB and repurchase agreements.
The GDB’s charter law calls for the Puerto Rico Treasury secretary to determine whether the bank is insolvent, who could then ask a local court to appoint a receiver to the bank, suspend operations and settle its obligations as soon as possible. The receiver would take over all assets and liabilities, as well as collect the bank’s outstanding loans, fees and claims.
Since the GDB serves as the principal depositary of funds of the commonwealth and its instrumentalities, access to these funds could be significantly limited if the bank is placed under receivership. Thus, a nuclear GDB fallout could contaminate the rest of the government operations at all levels, potentially affecting essential services, and thus, the rest of the local economy.
Emergency legislation for the bank could also seek to strengthen and further define the receivership process, including the powers to determine claims and their priority of payment, the commonwealth government conceded in a quarterly financial report filed late last year.
Seeing it coming
The GDB was conceived as an economic-development motor during the administration of Rexford Tugwell, a New Deal economist in the 1940s, tasked with driving the industrialization efforts of the times. Following its heyday, the bank slowly but surely became the lender of last resort for the commonwealth government and public corporations.
Fast-forward to the present, and the chickens have come home to roost.
To the very last moment before it ran out of lending capacity, the bank had been financing operational deficits and fruitless projects for years, with an asset portfolio chock full of delinquent loans and credit lines, a majority of them owed by public entities.
Government instrumentalities and municipalities owed the bank roughly more than $5 billion.
Take for instance the whopping $2.2 billion line of credit given to the Puerto Rico Highways & Transportation Authority (HTA), of which $1.9 billion still sits on the bank’s balance sheet. This loan traces back to the administration of former Gov. Luis Fortuño. That loan must be paid back or the GDB will have to reserve the loan as a loss, a move that could further stress matters beyond oblivion. During an interview in 2015, GDB President Melba Acosta forewarned that the HTA loan payment was critical to the GDB’s survival.
The crisis of solvency put the onus on the bank to improve its fiscal health and this was evidenced when it tried mightily to have the Puerto Rico Infrastructure Financing Authority successfully go to market with a $2.95 billion bond deal. Most of the bond proceeds would have gone to pay for the outstanding HTA loan.
A confluence of events, namely a delay in amendments to the petroleum-products tax, known as la crudita, that would have secured the intended bonds, and horrendous press on Puerto Rico’s debt crisis, made it impossible for the commonwealth to close the deal.
The legislative harangue in the run up to pass amendments to la crudita is emblematic of plots upon subplots in the hallowed halls of the Puerto Rico Capitol building, which would lead observers to the conclusion that some lawmakers would rather see the bank disappear altogether than throw it a lifeline.
Red flags over the bank’s fiscal health have been popping up for quite some time, with the gap between assets and loans continuously closing for at least the past two decades.
The past year and a half has certainly been a bumpy ride for the GDB, which saw a handful of its board members resigning their posts almost simultaneously during the summer. Then-chairman, David Chafey Jr., a former president of Banco Popular, was among those who exited. Popular, the financial institution recently opted out of being the trustee in charge of most of the GDB’s outstanding debt.
Meanwhile, Acosta has been acting as chairwoman, and three new members entered the board, including Office of Management & Budget Director Luis Cruz. La Fortaleza still has to fill one more vacancy on the bank’s board. The GDB law states that the governor would do so within 60 days following an untimely vacancy.
The García Padilla administration also enacted a highly debated measure that strengthened bank officers’ immunity provisions under the GDB’s charter law.
Given its limited access to external financing, the bank has also set in motion a host of measures in an effort to meet its liquidity needs and maintain operations. Legislation was enacted to require public entities to transfer to the GDB deposits held in private banks, as well as implement more strict lending controls for the government bank.
The GDB has also been selling chunks of assets to come up with cash. For instance, the bank posted earlier this month a notice for institutions interested in acquiring roughly $32 million in loans made by the GDB to various hotel projects.
All these maneuvers have been geared toward propping up liquidity levels at the bank. Yet, it has been months since the bank’s last official update on its cash position was released.
Uncertainty over GDB’s current condition
The last liquidity update reported by the GDB dates back to September, when it topped at roughly $875 million. At least two sources have confirmed to Caribbean Business that the GDB has stopped reporting its liquidity over concerns there could be a backlash at the bank, such as triggering a bank run that could turn out to have a deadly snowball effect on other government dependencies.
Since last year, the Financial Institutions Commissioner’s Office (OCIF by its Spanish acronym), which oversees the GDB, has been examining the bank’s operations and solvency, but has yet to release its findings.
Nevertheless, as a result of a legal dispute between the commonwealth and retail giant Wal-Mart over a tax imposed on the company’s local operations, a federal judge conceded that OCIF has already found the bank to be insolvent and receivership may follow.
The GDB’s ongoing audit processes have also affected the commonwealth’s long-overdue audited financial statements for fiscal year 2014, which must include an updated snapshot of the bank’s fiscal health. While government officials had pointed to the first week of April for the release of these statements, many observers remain skeptical about this deadline, given the island’s most recent fiscal developments, which could further delay their delivery—and a fresh look into the GDB’s state of affairs.
The bank has roughly $4 billion in outstanding notes, or debt, with short- and medium-term maturities ranging from 2015 through 2026, amid escalating interest rates. Most of this debt was issued during the previous administration, with the bank under the helm of former GDB presidents Carlos García and Juan Carlos Batlle, and chairman Marcos Rodríguez-Ema.
Last year, the GDB engaged in discussions with a group of creditors seeking to exchange existing notes for new paper and more favorable payment terms for the bank. But talks went south and suddenly ended in October, after failing to reach a “mutually acceptable arrangement,” the bank stated at the time.
The GDB said it would focus on achieving a broader, voluntary exchange offer for most Puerto Rico creditors—a process that has yet to gain traction, with advisers for all sides still going back and forth over several proposals that have been brought to the table. These include two from the government, while a third offer is already being discussed, although not publicly, sources have told Caribbean Business.
The bank could very well use some type of forbearance from its creditors while restructuring talks take place. Nevertheless, discussions with GDB creditors over such relief action have so far been unsuccessful, one source told this newspaper. It remains to be seen how the latest round of talks with creditors goes, but as is the case with the rest of the commonwealth, there is very little leverage, as of today, to have creditors voluntarily sitting down at the negotiation table.
“The bank’s existence will be perpetual,” reads the GDB’s charter law, enacted in 1948. Will the bank go under? And if it does, is there a viable Plan B to manage the island’s fiscal nitty-gritty during a debt crisis ready to go up a couple of notches? After all, as the island’s fiscal agent, the GDB leads all fiscal stability and debt-restructuring work for the administration, including overall talks with creditors. The bank serves as a sort of liaison between the commonwealth and its external advisers, chief among them, Millstein & Co.’s Jim Millstein, a former lead restructuring adviser for the U.S. Treasury.
Supporters believe the GDB should continue as an entity and be saved at all costs in an effort to bring it back to better times. Naysayers think it is time to move on. And then there are those who do not know quite yet what the best solution may be. All sides see the GDB as the elephant in the room; they stare at it aghast, but have yet to act.