P.R. Board Suggests 79% Cut in Fiscal 2019 Bond Payments

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The Puerto Rico Oversight Board said a 79% reduction in payments may be in store for bondholders in fiscal 2019.

The estimate is one of a series of observations and directions by the board in a letter sent Wednesday to Gov. Ricardo Rossell-. The board directed the governor to implement $4.5 billion in tax increases and spending cuts by fiscal 2019, the equivalent of 46% of the current fiscal year's $9.8 billion budget.

"The fiscal plan must target a structurally balanced budget by fiscal year 2019," the board told Rossell-. The structural balance would not necessarily cover the payment of debt service. However, if things follow as demanded, the board suggested that Puerto Rico may be able to pay $800 million of $3.9 billion of debt service due in that fiscal year, or 21% of what is due.

Even a payment of $800 million may be an optimistic reading of the board's projection for debt payment. The board wrote, "Please note that even with the immediate successful implementation of these measures the implied primary surplus available for debt service on fiscal year 2019 – before taking into account any legacy deficits – is $0.8 billion, which represents only 21% of the contractual debt service of $3.9 billion for fiscal year 2019." However, Puerto Rico already has legacy deficits to suppliers and unpaid bondholders well over $1 billion, and it remains to be seen if the board would direct the government to pay these first.

"The 21% figure is certainly a major haircut," said AllianceBernstein director of municipal credit research Joseph Rosenblum. "But that is in [FY] 2019 and remember that many of the discussions to date centered around proposals that had no principal repayment in the first five years. Looking at one year doesn't necessarily provide a total picture of ultimate recovery…. Some classes of debt may do better and some may do worse."

Municipal Market Analytics partner Matt Fabian said he was skeptical that the board was suggesting the government would pay 21% of debt due in fiscal 2019 and that the 21% figure was an "analytic" description of Puerto Rico's situation in fiscal 2019.

"While the board is also sending a message to bondholders that the commonwealth's ability to pay them has been severely compromised and that holders should be ready to consent to deep haircuts, they're not saying that the debt is totally unpayable, because they also continually talk about needing to regain 'market access,'" Fabian said.

The board makes a variety of specific recommendations for spending cuts of $3 billion and for revenue increases of $1.5 billion for fiscal year 2019. "Presenting a plan that can achieve at least this level of savings is a pre-requisite to certifying a fiscal plan," the board wrote. "The government may, however, determine to employ other initiatives and make trade-offs that differ from those described below, but arrive at a similar equilibrium."

The board adopts the projections by former Puerto Rico Gov. Alejandro García Padilla on Dec. 20 that the GNP would contract on a real basis by 16.2% in fiscal year 2018.

The 16.2% figure came from García Padilla when he was trying to promote a doomsday scenario of austerity, according to Inteligencia Econ-mica chairman Gustavo Vélez. Vélez said a single year contraction of more than 8% was "nearly impossible," and that shrinkage of 2.8% was the worst case scenario.

Vélez said nearly 30% of Puerto Rico's gross domestic product came in the form of federal transfer payments and that about 44% of it was in manufacturing for foreign consumption. Taking these facts together with the fact that Puerto Rico doesn't have its own currency indicates that Puerto Rico's economy has some stability, he said.

The board said that Puerto Rico's fiscal gap would be $7.6 billion in fiscal 2019 including debt service and would average $7 billion in fiscal years 2019 to 2026. The board's proposal doesn't cover all debt service due in fiscal 2019 and doesn't address the out years.

According to Fabian, the proposal's "inadequacy to correct the entire deficit means that other remedies will be needed, and they're basically asking the governor to provide those remedies."

For revenue enhancements, the board is suggesting an extension of the Act 154 tax on foreign corporation income, steps to improve tax compliance, increased government fees, excise taxes and tolls. These should bring in $1.5 billion annually.

The board also hopes to use cuts in government size and increases in its efficiency to reduce fiscal year 2019 spending by $1.5 billion. Specifically, it called for a 30% reduction in payroll costs through cuts in positions and compensation. It called for eliminating municipal government and private sector subsidies. It suggested that kindergarten to 12th grade spending should be cut to be consistent with reduced student populations.

The board called for annual $1 billion cuts in Puerto Rico's Medicaid program, miSALUD, partly through efficiencies and partly through cuts in benefits.

It called for $300 million in annual cuts to higher education spending and $200 million in annual cuts to Puerto Rico pensions.

The board told Rossell- that it was inclined to extend the deadline for him to submit a 10 year fiscal plan to Feb. 15 from Jan. 15, a deadline he has already missed. It also told him it was inclined to extend the stay on debt litigation to May 1 from Feb. 15. However, to do this it required the governor follow several conditions.

"The oversight board has put forward a realistic assessment of the scale of the fiscal adjustment needed in Puerto Rico after the Affordable Care Act funding runs out," said Brad Setser, senior director of the Council on Foreign Relations. "The reality has long been that Puerto Rico faces a series of fiscal cliffs in 2018 and 2019, and the scale of the fiscal adjustment required to close the primary fiscal gap (primary deficit is the budget, absent debt service) will be a major drag on the economy."

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