Monday, May 23, 2022

Puerto Rico’s Bare Cupboards

By on January 15, 2016

Cate LongOn Jan. 6, 2016, Puerto Rico’s 44-year-old Gov. Alejandro García Padilla met with local media in Utuado. The governor told the assembled reporters that he had paid down Puerto Rico’s debt from $72 billion to $69 billion without firing any public employees.

García Padilla also castigated credit-rating agency Standard & Poor’s (S&P) for creating a false story that blamed his administration for lack of audited financials.

One week prior, on Dec. 30, 2015, García Padilla held a press conference at the governor’s palace and announced the government would pay most of its debts due on Jan. 1.

The government had sufficient cash in the Treasury and various bond reserve funds that could be used to meet the payments. The government also announced that it had diverted $164 million of revenues assigned to several classes of debt to the more legally secure general-obligation bonds. The long-threatened “clawback” of debt service on weaker bonds had begun.

The Puerto Rico government scoured every nook and cranny to repay bondholders while insisting the island faced a “humanitarian crisis.” This crisis language was echoed by U.S. Treasury Secretary Jack Lew and Treasury adviser Antonio Weiss. Unsaid was that Puerto Rico had relied for decades on repaying its debts by issuing new debt. The commonwealth, cut off from market access, unhooked itself from its morphine drip and faced the hard reality of its unbalanced budgets.

Prior to the Christmas recess, the U.S. Congress deliberated on helping Puerto Rico. After intense lobbying by Gov. García Padilla and numerous Democratic lawmakers, Congress decided to add $90 million a year for commonwealth hospitals under the Medicare plan and give the U.S. Treasury new authority to assist with information systems.

House Speaker Paul Ryan promised that House committees would complete a plan to assist Puerto Rico by March 31, 2016. Meanwhile U.S. Senate chairs Orrin Hatch, Chuck Grassley and Lisa Murkowski filed legislation that would give Puerto Rico $3 billion in aid, impose a federal control board and commission various studies on the commonwealth’s pension systems and other government functions.

Government liquidity
The payment of 11 of the 13 debt classes due on Jan. 1 clearly signaled that Puerto Rico wouldn’t suffer a “death spiral” as no government services were reduced. Public services including police, healthcare and education continued to be provided to citizens and few government services were diminished. The government found sufficient cash to pay government salaries and an additional $120 million to pay Christmas bonuses to public employees.

In late December, the University of Puerto Rico (UPR) announced it had halted payments to outside vendors until mid-January to have sufficient cash to make payroll. It is unclear if the UPR had exceeded its budget or the Puerto Rico Treasury was executing a cash-management strategy with only one public entity.

Information about the true cash position of the Puerto Rico government is nearly impossible to obtain. The Puerto Rico government paid management consulting firm, Conway MacKenzie, $5 million to project their cash position. Conway’s August report projected that the central government would have a December negative balance of $200 million. The Puerto Rico government has had a long-term problem accurately projecting its expenses and revenues and previously maintained liquidity with massive short-term borrowings. Access to short-term borrowing ended when García Padilla declared all debts unpayable last June.

Debt-service payments
To make January debt payments totaling $901 million, Puerto Rico drew funds from various sources. Here is how each class of debt was paid:

* – Puerto Rico Government Development Bank stated that it had applied “available revenues” to pay $331 million in general obligation-debt including $164 million of revenues from the Highways & Transportation Authority (HTA), the Puerto Rico Infrastructure Financing Authority (Prifa, or AFI by its Spanish acronym) and the Convention Center District Authority (CCDA). This represents a diversion of funds not a draw from debt service reserves. Bond insurers Ambac and FGIC objected to the diversion of $94 million in PRIFA (AFI)  rum-tax revenues.

Bond insurance subsidiaries of Assured Guaranty Ltd. (NYSE:AGO) and Ambac Financial Group filed suit on Jan. 7, 2016 in federal court challenging the constitutionality of the revenue clawback instituted by the Commonwealth. Assured Guaranty has stated that they believe the clawback of revenues pledged to bond issues violates the U.S. Constitution by illegally interfering with Assured Guaranty’s contractual rights.

** ­ Prepa disclosed it had drawn $171 million from its general fund to make its $176 million Jan. 1 debt- service payment. It also drew $5 million from a bond service fund and federal subsidies held at its trustee to pay Build America Bonds. Prepa’s bond trustee, U.S. Bank, said in light of these transfers and payments, no payment event of default has occurred under the Trust Agreement.

Additionally on Dec. 29, 2015 Prepa executed a bond purchase agreement with Assured Guaranty, National Public Finance and the Ad Hoc Bondholder Group to sell $110 million in bonds maturing July 2019 at 10% annual interest. This sale provided funds to repay $130 million of bonds issued to the same group on July 1, 2015 at an interest rate of 12% that matured on January 1, 2016. In the intervening months Prepa repaid $20 million of the July 1, 2015 bonds.

Puerto Rico’s upcoming debt payments
Puerto Rico’s upcoming debt-service schedule includes two large payments. The first, due in February, is $318 million for the island’s secured sales-tax debt, known as Cofina (the Spanish acronym for the Sales Tax Financing Corp.). The funds for this payment have already been deposited at Banco Popular, the bond trustee, and it is extremely unlikely the government would go to court to break into the Cofina lockbox.

The second large payment is $422 million due in May 2016 for payment on GDB bonds. The GDB paid $354 million in debt service in December 2015, leaving it with insufficient liquidity to make the May payment. Puerto Rico’s financial regulator, Financial Institutions Commissioner’s Office (OCIF by its Spanish acronym), has supposedly judged the GDB solvent, but hasn’t publicly released its findings. Recently enacted Puerto Rico law gives the governor authority to put the GDB into receivership, and it is unclear if the governor is waiting on Congress to act on possible bankruptcy extension for Puerto Rico.

The Government Development Bank
Complicating issues around GDB solvency is that its largest balance sheet asset is a $2 billion loan to the HTA. And the government has begun clawing revenues away from the HTA to pay general-obligation debt. Normally, the HTA would be using some of those revenues to repay its loan to the GDB.

The government’s effort to strengthen its general-obligation debt is undermining the solvency of the GDB. This shortfall could be addressed by appropriations from the general fund if the GDB was determined to be a government priority.

Further complicating the maneuverings around GDB solvency is that Puerto Rico’s credit unions (cooperatives) own about $1.5 billion of “Transferable Securities,” of which some portion is Puerto Rico government debt including GDB bonds. To protect the co-ops from losses on Puerto Rico debt, the P.R. Legislature recently passed a special law allowing co-ops to amortize investment losses from P.R. government debt for 15 years. Amortization of these investment losses wouldn’t be allowed under federal credit-union regulations.

New cash-management procedures
The central government is taking new steps to manage its cash. Puerto Rico’s Treasury (Hacienda) published a circular (Puerto Rico Clearinghouse translation below) on Dec. 17, 2015, detailing how the central government would manage cash disbursement.

Hacienda Circular Letter No. 13001516
The payments related to public funds of the central government of the Commonwealth of Puerto Rico will be disbursed in accordance with the following order:

a. Interest and amortization of debt protected by the Constitution, in order of maturity.
b. Final judgments rendered by courts in cases of expropriation, for which an allocation for the fiscal year has been arranged.
c. Expenses incurred to ensure the following essential services:
    i. Public health
    ii. Security
    iii. Education
    iv. Public welfare
d. Payroll expenses and pensions, including all related contributions and retentions made.
e. Income under government custody belonging to external entities such as but not limited to funds related to Compulsory Insurance, the Administration of Automobile & Accident Compensation (AACA) and refunds, among others.
f. Any other expense previously provided that to the discretion of the Secretary of the Treasury is needed to ensure the operation, continuity and stability of the central government of the Commonwealth of Puerto Rico, as they are required to ensure the welfare of the inhabitants of the country.
g. In case of an emergency prompted by a catastrophe, natural disaster, acts of God or that somehow impacts the safety, health, education or welfare of the public emergency, preference will be given for the execution of that payment that best meets the normal and economic life of the country.

Puerto Rico fails to complete new financings
In the past year, Puerto Rico didn’t complete attempted sales of $2.9 billion in new fuel-tax debt or $750 million of debt for Prasa. The government also spurred offers of additional lending from general-obligation debt holders. This drying-up of liquidity caused the government to start drawing on debt-service reserves to make bond payments.

The government has been unable to provide audited financials for fiscal year 2014, which ended June 30, 2014, despite repeated requests from members of Congress for these documents. Financial projections by paid consultants of the Puerto Rico government have consistently been inaccurate.

Puerto Rico has paid down $3 billion in debt in the past year without reducing government headcount or public services and no market access. Congress and bond-market participants stand ready to assist with the crisis, but need a clear picture of the financial condition of Puerto Rico.

Congress will be holding a series of hearings this winter to learn more about Puerto Rico’s fiscal condition. As more information emerges, solutions for Puerto Rico will be developed. Expect Congress to act before May.

Cate Long, Partner, Puerto Rico Clearinghouse. Follow Cate on Twitter at @cate_long.


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