MuniLand

The push and pull over Puerto Rico’s budget

By Cate Long
May 1, 2014

Things are buzzing in Puerto Rico after Governor Alejandro Garcia Padilla gave his annual fiscal address in which he proposed his budget for fiscal year 2015. The government also held a conference last week to attract new investors.

Puerto Rico also filed notice with the MSRB that it is unable to complete its 2013 fiscal year financials on time. They will be published sometime later this quarter. Bond issuers are responsible to file their audited financials within 305 days after the close of the fiscal year. It is unusual for a state-level issuer to miss the reporting deadline. Bond investors don’t seem concerned, however, as they traded the new $3.5 billion general obligation bonds due 2035 near the original offering price of 93.

Legislation was also filed right after the budget was proposed to declare a three year state of fiscal emergency for the Commonwealth. Noticel reports:

The executive filed a law on Wednesday to declare a state of fiscal emergency to extend spending cuts to public corporations and autonomous bodies and force unions to renegotiate collective agreements. The budget contains a total of $ 1.357 million in savings, of which 27 percent came from a freeze on increases.

Governor Padilla’s budget speech on Tuesday was in Spanish, but there has been plenty of English language reporting of it. Local leaders told me the speech was engaging, combative and played to the unions and members of Puerto Rico’s legislature who will negotiate and refine the budget. But the real language for bond investors was the hard numbers presented by Padilla’s administration. Here are the essentials:

  • Total proposed fiscal year 2015 general fund budget of $9.64 billion – a 1 percent decrease in spending over FY 2014.
  • $1.5 billion in spending reductions
  • A laundry list of tax changes and adjustments are projected to raise $570 million in new revenues (see details at end of post)
  • $1.274 billion of the budget will go to bond payments (13 percent)

Puerto Rico

The budget promises no layoffs for government employees although there are proposed reductions in benefits. Caribbean Business reports:

The $1.5 billion reduction in projected spending will be obtained through a far-reaching government overhaul that will include the closure of about 100 public schools, elimination of 23 public agencies, restructuring of public corporations, a 7.5 percent reduction in central government spending, and freezing of scheduled annual automatic pay hikes for the judicial and legislative branches, as well as the University of Puerto Rico, Office of Management & Budget Director Carlos Rivas said.

The commonwealth will not cut government jobs or reduce public employees’ work hours or salary. Employees who work at agencies slated for shutdown will be absorbed by related government entities.

Daniel Hanson of Height Analytics predicts a $1.5 billion fiscal drag on the Puerto Rico economy from new taxes and spending reductions. Hanson said in a report that if the governor’s budget is adopted, the Puerto Rico economy will have absorbed approximately 4 percent of fiscal drag on gross national product between July 2013 and July 2015. Hanson projects that Puerto Rico economy will stay in a mild recession through fiscal year 2015.

Municipal analyst Triet Nguyen of Axios Advisors raised the issue of public corporations, which have been sucking money from the general fund. Nguyen writes:

Away from the balanced budget talk, the Governor’s speech did little to dispel investor concerns about the potential restructuring of the public benefit corporations (PBCs). One may wonder if the Commonwealth is not trying to bolster its G.O. credit at the expense of the PBCs. After all, the plan is to wean the PBCs from the Government Development Bank for liquidity support and force the agencies to be self-supporting, which is easier said than done: PREPA, for instance, needs further capital market access to complete its ambitious capital improvement program. We doubt it can accomplish that in its current financial state without ongoing help from the central government.

Puerto Rico was able to defer interest costs on the new $3.5 billion of general obligation bonds due 2035 by capitalizing part of it for the first three years. Although the government has vowed to aggressively pay down its debt, this will weigh on future budgets. Nuveen chart:

Puerto Rico

Governor Padilla proposed an ambitious reinvention of the Commonwealth government that could negate a need to restructure the Commonwealth’s debt. He is betting that retrenching government spending will recharge the economy. Time will tell if the proposed government changes can be executed and the economy rebounds. The anonymous blog Puerto Rico Commentary took a contrary view and wrote:

As promised, the Governor proposed a balanced budget, displaying a degree of political courage worthy of commendation. Treasury Secretary Melba Acosta provided some overall perspective saying: ‘The recovery plan is similar to plans presented by Ireland when its credit was downgraded and which is now today investment grade. It’s about economic development and offering jobs to citizens.’

Unfortunately, Ms. Acosta left out some important details. Ireland—as do most countries facing acute financial difficulties—-parlayed a commitment to fiscal austerity into an agreement (in this case with the European Central Bank) to restructure its debt and to secure a funding backstop. The great fear of horrible consequences from a debt restructuring do not appear to have befallen Ireland and most likely would not have Puerto Rico either.

The $ 540 million of proposed tax increases

1. Elimination of Employment Credit $124 million

2. Seniors payment $400 only if certain precautions are given goals, if not, ensure maximum

$200, postponing payment between July and October 2014 $100 million

3.  Food Basket: clarifying taxation of certain products between merchants $10 million

4. 5 percent tax on Remittances (Total $30 million, $15 million spent on housing projects) $15 million

5. PC. 1362 : Charges to the therapeutic use $5 million

6. Law No. 83-2010 , Amendments to the Green Energy Fund $10 million

7. Fines ATI – Roads which pass SB 851 (negative $39 million)

8. Measure regulating illegal gaming machines and impose certain charges $10 million

9. Taxation of passive income $30 million

10. Modify the capital gain tax on corporations $30 million

11. Adjust the alternate basic tax (AMT) $32 million

12. Dividend of 4 percent in foreign assets of regular corporations (creditable ) $30 million

13. Amendments to legislation on collection of Sales and Use Tax (Cofina) $170 million

14. Implementation Powerball (does not require legislation) $13 million

Comments
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No one can turn a moving ship on a dime. We can only salute Mr. Padilla and his team for devising and proposing what they did. As investors, we should be rooting for their success instead of constantly forecasting PR failure.
Just look at the mainland US budget. Any downpayment of debt whatsoever? Nope. Any *accelerated* downpayment of debt? You must be kidding!
The US interest payments on debt are just over 6%, but only because “By comparison, debt service was more than 15% of federal outlays in the mid-1990s; the share has fallen partly because lower rates have held down interest payments, but also because outlays have risen substantially: up 39.4% over the past decade.” goo.gl/vDQ7C6
So, the mainland has a lower % outlay only by “printing” more money and spending like crazy on other things, a luxury PR certainly does not have.

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