Puerto Rico slides toward insolvency
#PuertoRico‘s projected structural deficit for FY ’13 is $2.15B, higher than what was originally informed to credit agencies, Moody’s, S&P.
— News is my Business™ (@biznewspr) March 14, 2013
Dark clouds are hanging over Puerto Rico. Its projected 2013 deficit follows a likely 2012 deficit and twelve preceding deficits stretching back to 2000. The economy has not been generating sufficient tax revenue to support the services that the government has been providing to citizens. The difference has been made up by borrowing in the bond market and loans from the Puerto Rico Government Development Bank.
Now the bond market gatekeepers, – credit ratings agencies – are waving the red flag. Yesterday Standard & Poor’s downgraded the Commonwealth of Puerto Rico to BBB- (one tiny step before junk status) and followed this downgrade with one of the island’s Government Development Bank to BBB-. This is ominous. The GDB is the heart of Puerto Rico’s borrowing system.
However, Puerto Rico is unique in its extensive use of public corporations to deliver public services. It directly and indirectly manages 48 public benefit corporations. This governance structure has tended to limit transparency and fiscal accountability in its public sector…
The island’s most important public corporation is the Government Development Bank (GDB). The GDB is the fiscal agent, paying agent, financial advisor, and primary lender to the Commonwealth, its political subdivisions, and its public corporations. Puerto Rico’s growth and financial stability require a healthy GDB.
Standard & Poor’s said in their GDB downgrade statement:
Our negative outlook on GDB mirrors our outlook on the commonwealth. If we lower our rating on the commonwealth, we will very likely lower our rating on GDB. We do not believe that GDB is sufficiently independent from the commonwealth to justify a higher rating. If GDB pays a large special dividend, which we do not view as likely, significantly increases its exposure to the commonwealth as a source of permanent deficit financing, or continues to shift its funding base toward wholesale borrowings, we could lower the rating–even if the rating on the commonwealth remains the same.
What is going on with the balance sheet of the GDB? I wrote last October:
[B]ut a look at the balance sheet of the GDB is not reassuring. Intergovernmental lending by the GDB has increased rapidly in recent years. The bulk of GDB assets are loans to Puerto Rico municipalities and intergovernmental entities. These loans stood at $7.211 billion as of June 30, 2011, having increased from $5.675 billion in 2009 (page 9) (a list of GDB loans not including PR municipalities are on page 15). The GDB has rapidly increased its borrowing from the bond markets as public deposits at the bank have decreased.
The GDB balance sheet is only as strong as the ability of the government units to repay their loans to the GDB. With Puerto Rico’s economy so weak, this would require very close monitoring.
For a glimpse at how Puerto Rico’s economy is doing, here is the December 2012 employment data from the GDB:
Employment, the engine of every economy, continues to sink.
Although the governor, Garcia Padilla, has proposed reforms to Puerto Rico’s pension system, it is currently a shambles. Many of the assets of the pension funds, which should be used to pay out benefits to retirees, are loans to pension fund members – not very liquid. From Noticel (Google Translation):
While adding that “due to the amount of personal loans originated in recent years, the system’s investment portfolio now has a significant item of illiquid assets. In an effort to improve the situation, the Board of Trustees of the System of Public Employees in 2011 passed a resolution to reduce the maximum borrowing back to $5,000 and, in 2012, approved the sale of about $313 million in loans.”
In December 2012, the loan portfolio of the Retirement System Central had a balance of $804 million, with personal loans half of the net assets of the System, which represents “a serious obstacle to their solvency.”
Between 2006 to 2010, the value of the loan portfolio of the Central Retirement System totaled about $ 2.3 million for a total of 294,251 loans approved.
The downgrade of the Commonwealth by another rating agency, Moody’s, in December 2012 to Baa3 (also one tiny step from junk) preceded the latest pension reform proposal and estimate of the 2013 deficit. The data is getting worse and the challenges that Puerto Rico faces are accelerating. What does the bond market say? Does the market stand ready to buy more Puerto Rico debt? Now it is clear that Puerto Rico must continually borrow to pay its bills and roll over old debt. How will this end?