Puerto Rico board says future may be bleaker than expected

Bonds

Puerto Rico’s Oversight Board said there may less money to pay bondholders than it has projected and Puerto Rico’s $18 billion in bank accounts allows for no additional money to pay bondholders.

The board made these arguments in two documents it made public on the Electronic Municipal Marketplace Access web site Thursday night. The documents had been circulated to bondholders over the last 30 days in confidential mediation talks.

Lower-than-projected levels of federal aid for reconstruction after Hurricane Maria may reduce economic growth, the Oversight Board said.

Bloomberg News

Government financial reports since Hurricanes Maria and Irma hit in late summer 2017 have shown more revenue than either the board or the local Treasury Department had projected. Some bondholders have used those reports to urge a more generous settlement.

The first document, “Commonwealth Fiscal Plan Risks,” argued that several sources of revenue have been coming in more slowly than the May-approved fiscal plan had projected, existing sources of revenue could easily take substantial cuts, and that there was a danger that needed structural adjustments would not be made.

“There are no game changers in this document,” said John Ceffalio, AllianceBernstein municipal credit analyst.

“The discussion of the risks to the fiscal plan is instructive,” Ceffalio continued. “The plan is fragile and the disclosure outlines the many reasons for this fragility.

“Two things stood out to me. First, this confirms the slower than expected pace of disaster aid. This is concerning because disaster aid is the only positive driver in today’s Puerto Rico economy. Second, the document highlights the deterioration of local [sub-Commonwealth level] government finances. This likely means austerity at the local level, which would be an economic drag, and I worry it may also mean restructuring the debts of those local governments.”

Ceffalio said since Puerto Rico has historically been weak with disclosure, he welcomed the release of information.

“The Commonwealth Fiscal Plan Risks document does a nice job of discussing the many factors potentially affecting the surplus projections for Puerto Rico,” said Robert Chirinko, University of Illinois professor.

“Commonwealth Fiscal Plan Risks” points to several ways the board’s fiscal plan projections for revenue may be overly optimistic. As reactions to economic or political uncertainty, population could decline more quickly than had been projected. Another storm, financial crisis, or health epidemic could also be causes of greater migration.

Puerto Rico could get substantially less federal Hurricane Maria and Irma disaster aid than the plan had projected. The board’s “Commonwealth Fiscal Plan Risks” says there might be a $30 billion shortfall on what it had projected to be $69 billion in aid. Also this aid is being delivered more slowly to the island. If the former materializes or the latter continues, there would be less economic stimulus than the fiscal plan had expected.

The board said the federal government may also cut its funding of local Medicaid.

The board points out that 85% of the exceedance in fiscal year 2019 revenues compared with the May fiscal plan came from just four taxes: corporate income taxes, Act 154 foreign corporate excise tax, motor vehicles, and other General Fund revenue.

Experience shows that corporate income tax booms are usually followed by busts, the board said. Puerto Rico is particularly susceptible because much of the corporate income tax revenue comes from just a few corporations.

The Act 154 revenues could be lost quickly when the United States revokes tax creditability for U.S. taxes, as U.S. Secretary of the Treasury Steven Mnuchin has said will be done.

The surge in motor vehicle tax revenue after the hurricanes appears to be subsiding, he said.

On structural reforms the report said, “the government is behind on implementing all of the major structural reforms required to drive economic growth on the island.”

Of particular concern are the potential impact of energy and ease-of-doing-business measures. The board estimates the former would contribute $12.9 billion to surplus for fiscal year 2019 to 2049 and the latter would contribute $16.6 billion in that period.

Additionally, the board said that its government fiscal measures are at risk. Due to local government inaction there is a possibility of reducing full time equivalent employment by 50% less than the fiscal plan envisions. That would cost Puerto Rico $20.3 billion from fiscal 2019 to fiscal 2049.

The board’s efforts to curb healthcare costs are imperiled by poor implementation and new federal benefit requirements. Together these could cost the government $27.8 billion through fiscal 2049.

The board’s fiscal plan projects to reduce subsidies to the University of Puerto Rico and municipalities. A lack of progress in lowering these costs, could force the central government to continue these subsidies. That might cost $16.3 billion through fiscal 2049.

The board points out that 21% of all municipalities rely on Commonwealth government subsidies for at least 40% of their revenue and 41% of municipalities rely on these subsidies for at least 30% of their revenue.

The second document the board released Thursday evening says that of $18.06 billion available as of June 30, $11.11 billion was restricted or was for non-Commonwealth central government or non-Title III bankruptcy entities. This left a total of $6.9 billion potentially available for debt payments.

However, the board said there were already claims for all of this money. First, the board is setting aside $2 billion for a “base cash consideration” for general obligation and Public Building Authority bond holders. It also assumes $2 billion for a “working capital requirement,” $1.6 billion for “union and retiree settlements,” $900 million for “maximum excess cash,” $632 million for purchasing Employees Retirement System assets, $400 million for a “cash/bond consideration toggle,” and $200 million for “convenience class.”

If these sums are set aside, the government is hypothetically left with an $827 million deficit.

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