The push and pull over Puerto Rico’s budget

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.

A macro view of Puerto Rico

Puerto Rico Governor Alejandro García Padilla will present his budget tonight. He has promised that it will be balanced, it will not require layoffs of government employees and it will not provide subsidies to Puerto Rico public corporations like PREPA (the Puerto Rico Electric Power Authority) or the highway authority.

Bloomberg is reporting that, according to the governor’s chief of staff, there will be no borrowing from the capital markets and the budget will not include debt restructuring. If the proposal is enacted as described, it will likely have a slowing effect on the island’s economy.

Richard Carrion, the current chairman and CEO of Puerto Rico’s largest bank, Popular, Inc., said in an interview with Sincomillas:

Puerto Rico’s electricity monopoly is worth half its debt

There is a reason that the uninsured revenue bonds of Puerto Rico’s electricity monopoly, known as “Prepa,” have been trading around 60 cents on the dollar. The utility is only worth about half of its 6.9 billion of long-term debt. Caribbean Business reports:

A 2012 confidential report obtained by CARIBBEAN BUSINESS says government utility [Prepa] is worth half its long-term debt…

The Álvarez & Marsal report on Prepa found that the government utility was worth about half of its outstanding long-term debt. Its preliminary value range for Prepa was $3.5 billion to $4.1 billion at a time when its net debt was $6.9 billion. The report also found that its value could be increased by as much as $1.2 billion through a full implementation of performance improvements that would bring one-time savings as well as ongoing operating cost reductions.

The fragile tax structure in Puerto Rico

The Puerto Rico government set a high hurdle for itself last year when it ramped up its 2014 tax revenue projection to $9.5 billion from the $8.3 billion collected in 2013. It did this by expanding the tax base for the sales and use tax (SUT) by approximately 26 percent, increasing corporate income tax rates and reversing reductions planned for the corporate excise tax (Act 154) paid by multinationals operating on the island.

The Act 154 tax rate was on track to be reduced to 2.5 percent in 2014 and then expire in 2016. Instead, the tax, which comprised 20 percent of 2013 revenues, was increased to 4 percent and extended to 2017.

The additional revenues from these tax increases allowed the government to borrow less for deficit financing in 2014, but created a high revenue threshold since the economy remains mired in an eight-year recession.

Puerto Rico government stumbles on teacher pension reform

The Puerto Rico government encountered a stumbling block in its efforts to right a sinking fiscal ship on Friday when its Supreme Court ruled that legislation amending the teacher’s pension system was unconstitutional. Reuters reports:

The Puerto Rico Supreme Court on Friday struck down a recently enacted overhaul of teachers’ pensions, dealing a major blow to efforts to fix the Caribbean island’s crumbling economy and budget.

Five of the court’s nine members determined that significant portions of the reform law were unconstitutional. Three judges dissented and one recused himself.

The Puerto Rico corporate tax question

The Government Accountability Office published a report estimating the economic advantages and costs Puerto Rico would have if it enters statehood. The biggest cost would be that Puerto Rico citizens would be required to pay federal income tax on their domestic earnings. Currently they pay federal income tax on income they earn outside of Puerto Rico.

The GAO estimates that If Puerto Rico had been a state in 2010, the estimated income tax paid by individual taxpayers would have ranged from $ 2.2 to $ 2.3 billion. The report also estimates changes in federal entitlement benefits that would flow to the island. In many cases there would be additional federal funds for the island.

The critical piece of the puzzle would be the change in income taxes for Puerto Rico corporations and subsidiaries of U.S. corporations that do business on the island. These corporations are a big contributor to Puerto Rico general fund revenues. Puerto Rico corporations are currently treated as foreign corporations under U.S. tax law. Here is what the report says (page 115):

Is muniland doping the data?

Puerto Rico and New Jersey may have played with the numbers recently to put a better gloss on their weak finances. They seem to be “doping” the data.

For example, Puerto Rico (with assistance from the Bureau of Labor Statistics) has revised six years of employment data to cast a positive upward revision to its economy. This had spillover effects on the broad economic measures of the island. From Puerto Rico’s Government Development Bank:

The payroll employment benchmark revision not only impacted the average level of payroll employment, it also changed its average growth rate for previous years.

Puerto Rico wants to return to the market for another $2 billion

I talked with Erin Ade of RT about Detroit and Puerto Rico. The interview starts at 3:40.

Meanwhile, on Thursday Caribbean Business reported that Puerto Rico intends to return soon to the market to borrow another $2 billion.

The government is planning a $1.5 billion deal through its Sales Tax Financing Corp (Cofina by its Spanish acronym) and a $500 million deal through its new Municipal Financing Corp (Cofim by its Spanish acronym) financing vehicle, according to Caribbean Business sources.

Puerto Rico’s local Chapter 9

Senate Bill 993 was recently proposed in the Puerto Rico Senate to create a mechanism for public corporations to be restructured. Since Puerto Rico is a commonwealth of the United States, it is excluded from Chapter 9 municipal bankruptcy code. There is currently no legal framework for a reorganization of liabilities. The legislation would establish such a framework.

Late Friday night (9:30 pm EST) the government issued a statement denying that they had any involvement in drafting the legislation:

In response to market speculation regarding Senate Bill 993, filed yesterday in the Puerto Rico Senate, which seeks to establish a legal mechanism to restructure the public debt of the Commonwealth’s public corporations, the Government Development Bank for Puerto Rico (GDB) and the Treasury Department wish to clarify that neither the GDB nor the Executive Branch proposed, reviewed, authorized or were in any way involved in the drafting or formulation of this legislation.

Puerto Rico’s local Chapter 9, a good start

This is a guest post by Puerto Rico attorney John Mudd. He writes about the new legislation filed in the Puerto Rico Legislative Assembly to allow the restructuring of public corporations.

Yesterday, Senators Nadal Power and Rosa Rodríguez filed a proposed act by which PR’s public corporations could reorganize its debts or even liquidate themselves. Essentially a local Bankruptcy Chapter 9. Both should be congratulated for having the moral fortitude to admit this must be considered. The preamble correctly indicates that state law may regulate those areas where Federal Bankruptcy law is silent or those entities excluded from the Bankruptcy Code, such as insurance companies or Puerto Rico’s municipalities and public corporations, expressly excluded via 11 U.S.C. § 101 (52). Moreover, the liquidation procedure of the P.R. Civil Code, Articles 1811-29, 31 L.P.R.A.  §§ 5171-5214 is totally obsolete since it dates back to the 19th Century.  In addition, the Preamble to this Act states that it is obsolete, making this a special law that preempts the more general law of the Civil Code.

The piece is a good start but lacks many of the necessary statutes that makes the Federal Bankruptcy Code a unique tool. Moreover, it should include the island’s municipalities, most of which are insolvent. In addition, it would make some sense for the law to require that some of the Commonwealth Courts be set for this type of procedure which will elicit massive litigation once it is started. Also, its judges should be especially trained in bankruptcy and dispute resolution since at this time the Puerto Rico bench is devoid of such knowledge. Now I will go to the specific areas that need to be added to the law. For your reference, I include English and Spanish versions but the statute states that the English version will prevail in case of doubt.

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