New austerity and confidence in Puerto Rico

July 18, 2014


Five months after Puerto Rico officials talked publicly to market participants, they held an investor call on Thursday with over 2,000 people. The call was captured by Storify. Puerto Rico’s previous call in February rallied market enthusiasm for a $3.5 billion general obligation bond offering that was priced on March 8. The March deal, the largest speculative grade bond deal ever done in muniland, replenished the coffers of the fiscally debilitated island.

Now the government is hoarding that cash and taking “swift and decisive” actions to clean up its internal capital structure. It is paying back internal loans between the central government, the Government Development Bank (GDB) and public corporations. Officials said that they had eliminated virtually all interest rate swap contracts at the GDB. They outlined new revenue sources and detailed expense reductions for general government operations.

The government reiterated that it intends to “ring fence” the debts of several public corporations while protecting their constitutionally-guaranteed general obligation debt and sales tax-backed Cofina bonds. An investor group that owns about $3 billion in Puerto Rico general obligation and Cofina debt announced that it supports the government and stands ready to assist Puerto Rico with financing.

At the opening of the call, Governor Alejandro García-Padilla said “our commitment to honoring financial responsibilities of Commonwealth remains unshaken.” Officials seemed confident and committed to imposing austerity on the government’s expenses.

“We believe that rating agencies have seriously misunderstood and misrepresented the intentions of the government,” said David Chafey, president of the Board of Directors of the GDB. Chafey stated that the government had a sufficient “liquidity runway” to sustain its capital needs, but had expected to access the market again in the short term. Chafey said that the GDB is “dedicated to working on a consensual agreement with our creditors.”

The government’s debt strategy is two-fold. First is to negotiate a reduction in debt, believed to be $8.3 billion of the electric monopoly Prepa’s, and to find new lenders for its short term borrowing needs.

Officials said that they planned to borrow $900 million in the next three months using tax anticipation notes (TANs). The water monopoly, PRASA, needs to refinance $200 million in bond anticipation notes before March 2015. Officials said that they would not refinance any general obligation or sales tax-backed Cofina debt, but they could do additional borrowing via the Cofina structure if market conditions permitted.

For the first time since 2009, Puerto Rico will pay its full general fund debt service of $1.2 billion without refinancing it with new debt. This would be a substantial milestone for the government.

The government’s funding vehicle, the GDB, has significantly strengthened its balance sheet. GDB’s investment portfolio increased from $1.5 billion to $3.2 billion, the total loan portfolio was reduced by 11.3 percent (from $9.8 billion to $8.8 billion) and GDB deposits increased $650 million over the last six months.

Puerto Rico said that they will vigorously defend Act 71, its new public corporation restructuring law. The market suspects that Act 71 will first be applied to Prepa, the electric monopoly. The government said that it intends to treat all creditors equitably. Oppenheimer Funds and Franklin Templeton sued the Commonwealth last month, asking a federal judge in U.S. District Court in Puerto Rico to strike down the law. Puerto Rico said it will formally respond to the lawsuit in the “next few days.”

Officials beat down two market rumors. The GDB’s Chafey denied that the electric monopoly Prepa had used funds from its capital reserves to buy fuel as reported in the press. Chafey said that the public corporation had permission to use these reserves, but did not. Officials also stressed that Prepa was not in default of bond covenants. No rating agency has said that Prepa is in default.

Governor García-Padilla announced that the government will submit a plan for comprehensive tax reform during the first half of the fiscal year.

Puerto Rico is quietly undergoing a forced austerity. The government detailed actions that include a new budget, which began July 1, that seeks to eliminate the general fund deficit one year ahead of schedule.  This will be Puerto Rico’s first balanced budget in 22 years. The Fiscal Sustainability Act (66-2014) declares a state of emergency and gives the government more flexibility to get to budgetary balance and phase out financing of budget deficits. Act 66 remains in place until July 1, 2017, or when certain economic and fiscal conditions are met, including an upgrade to investment grade by one major rater.

The government’s agenda is ambitious:

Puerto Rico

Some reactions to the Puerto Rico investor call from Nuveen’s Shawn O’Leary and Dr. Arturo C. Porzecanski of American University:

#MuniLand Puerto Rico failed to reassure bondholders-panel

— Reuters Insider (@ReutersInsider) July 17, 2014


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