Puerto Rico partly opens the kimono
Puerto Rico held a long-awaited investor call on Tuesday. In a highly scripted performance, participants delivered statements that accompanied the presentation slide deck. The call lasted one hour and 20 minutes and no questions from attendees were answered. Written questions submitted two weeks prior were addressed. Important issues of government liquidity and the proposed 2015 budget were briefly detailed.
Puerto Rico Governor Alejandro Garcia Padilla, in a pre-recorded talk, opened the call with an update on the commonwealth’s fiscal and economic progress over the last 13 months. He said that he was proud to have acted rapidly to address problems that were created years and possibly decades ago. He said that politics have been put aside.
Government solvency and the Government Development Bank’s (GDB) liquidity are the key focus for investors. Incomplete data made it hard to assess whether sufficient cash flows exist to service short-term liquidity needs and repay additional debt service for a proposed $3 billion dollar general obligation debt offering.
Details of the GDB’s investment portfolio and deposit base were shown, but they included no accounting of the loans that have been made to the government and public corporations (page 8 and 9). The most recent balance sheet data for the GDB is now 20 months old.
For example, $1.1 billion of short-term financing needs were detailed on page 11 (slide below), but these liquidity needs did not match the proposed use of the new $3 billion of borrowing detailed on the following slide.
Maybe the GDB will sell part of its $2.7 billion investment portfolio to cover these liquidity needs. The use of proceeds for the proposed general obligation bond deal is below. It appears to address other liquidity needs:
The above proposed general obligation (GO) plan of finance includes only $245 million of 2014 deficit financing, but the government has a revised deficit of $650 million for the year. It’s unclear if the additional $405 million of deficit financing would also be drawn from the GDB’s investment assets.
During the call, the 2014 revenues and 2015 budget were quickly reviewed. Carlos Rivas, Director of the Office of Management and Budget, said that there is an outside possibility that the 2015 budget would be made public in March. Unfortunately, the 2015 budget is unlikely to be made public before Puerto Rico brings its general obligation deal to market. This lack of forward-looking information will make it difficult for bond investors to assess the liquidity and solvency of the Puerto Rico government.
Puerto Rico said that its 2013 Comprehensive Annual Financial Statement (CAFR) will be issued this May. This would come after a new GO deal would be brought to market. The GDB financials were promised in next few weeks.
After the call, the Puerto Rico government issued a quarterly statement that revealed more financial information. Especially relevant was disclosure related to the GDB. The circular nature of the funding relationship between the GDB and the Puerto Rico government is detailed here (page 6):
Loans to the Commonwealth and its instrumentalities constitute a significant portion of GDB’s assets. As a result, conditions that adversely affect the ability of the Commonwealth and its instrumentalities to raise cash (including access to the bond market) and repay their interim and other loans to GDB also have an adverse effect on GDB’s liquidity and financial condition.
As Puerto Rico’s access to the borrowing market was constrained, the intertwined funding relationship between the government and GDB was accelerated (page 6):
One challenge that GDB faces is limited liquidity. The liquidity position of GDB has been adversely affected by, among other factors, the significant increase in credit spreads for obligations of the Commonwealth and its instrumentalities during 2013, by the limited market access experienced by the Commonwealth and certain of its public corporations during the second half of calendar year 2012 and calendar year 2013, by a significant reduction of liquidity in the local Puerto Rico capital markets, and more recently by the credit downgrades described above.
This led to a seize-up in liquidity:
These factors have resulted in delays in the repayment by the Commonwealth and its instrumentalities of their loans to GDB and, at the same time, caused the Commonwealth and its instrumentalities to rely more heavily on short-term financing and interim loans from GDB and other lenders.
The government must be able to access the bond market to stanch the liquidity spiral:
The Commonwealth needs to obtain significant additional funding before the end of the fiscal year in order to repay interim loans and other obligations that are owing to GDB, and therefore allow GDB to continue serving as liquidity provider to the Commonwealth.
These disclosures contradict the common wisdom that Puerto Rico is bringing a bond deal to satisfy the rating agencies. The government must raise funds to repay the GDB so it can continue funding the government and other public agencies.
The Quarterly Statement details additional liquidity demands on the GDB (page 4). It also reveals new budget expenses that have not been previously disclosed. In 2014 the Puerto Rico government must repay the U.S. Treasury for overpayments made through the American Recovery and Reinvestment Act (page 17):
In order to provide the tax credit to residents of Puerto Rico, the United States Treasury paid the Puerto Rico Treasury Department approximately $1.2 billion. The Commonwealth was to return the balance of ARRA funds not spent as of December 31, 2013. As of December 31, 2013, the balance owed to the United States Treasury was $349 million, including $300 million that was not spent on MWPC and $49 million in overpayments made to certain taxpayers. The Commonwealth has reached an agreement with the United States Treasury to return the fund balance of $300 million in monthly installments of $25 million beginning on February 3, 2014 until the balance has been repaid.
This appears to be an additional $125 million of expense for the 2014 budget and $225 million for 2015. It is not clear if this expense has been incorporated in the $650 million 2014 deficit figure.
The Quarterly Statement projects mandatory cost escalators for the fiscal year 2015 budget in the range of $700 million to $800 million (page 9). These escalators will have to be reconciled with Governor Garcia Padilla’s desire for a zero budget deficit for fiscal year 2015. A zero budget deficit for 2015 requires a $400 million spending reduction that brings total spending cuts to $1.2 billion before any increase in new debt service is factored in. The escalators include $173 million in incremental costs from collective bargaining agreements and legislated labor benefits and $132 million in incremental, formula-based appropriations for the judicial branch, the University of Puerto Rico and the municipalities.
These escalators can be partly offset, but will require legislative action:
These cost escalators are expected to be partially offset by a number of anticipated cost reductions, particularly a lower starting employee headcount, fewer anticipated sick and vacation leave payments, and carryover funds from unused appropriations.
Jose Pagán, Interim President of the GDB, said that Puerto Rico plans to go to market next month with a GO deal. He has asked for legislative authority to bring a $3.5 billion general obligation offering. He said that the GDB will detail its liquidity ahead of the offering.
I have written previously that Puerto Rico may not have a sufficient debt limit capacity to do a GO offering of this size. Constitutional debt capacity was not discussed on the call, although I requested that it be addressed. The Quarterly Statement details current debt service (page 29).
The other critical issue for Puerto Rico relates to tax revenues. It has been unclear what will happen to the corporate excise tax (Act 154), which is about 20 percent of Puerto Rico’s general fund revenues. Melba Acosta, Secretary of the Treasury, stated that they were not considering raising the Act 154 tax. She said that after 2017, the way that the tax is calculated will be modified, but it will not expire. This is the corporate tax that has not explicitly been approved by the U.S. Internal Revenue Service.
Puerto Rico provided investors with a little more disclosure this time. Is this enough information for bond investors to make a decision about the solvency of Puerto Rico? Maybe not. Hopefully the official statement for the proposed GO deal will provide more disclosure about future cash flows and expenses.