Why Puerto Rico's Credit Unions Are the Latest Debt Crisis Flash Point

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Puerto Rico economists are concerned credit unions, which provide financial services to more than a third of the island's citizens, may prove vulnerable as the debt crisis ripples through the local economy.

Credit unions in Puerto Rico have a greater role in personal banking than they do in the 50 states, as 1.2 million of the island's 3.5 million residents are either members or depositors. And the depositors are disproportionately low-income and elderly, according to Advantage Business Consultants president Vicente Feliciano.

The credit unions, also known as financial cooperatives, this month moved to the forefront of the debate over how to shield citizens from the fallout of the island's fiscal crisis as legislators weighed a measure to protect cooperatives' deposits at the Government Development Bank under proposed amendments to a payment moratorium bill that they passed in April.

The credit unions hold as much as $1.5 billion of Puerto Rico bonds, prompting concern that some may not have enough capital to absorb losses if auditors decide the securities have to be marked down.

"I'm sure there will be a number of co-ops that will not be able to survive," Heidie Calero, president of H. Calero Consulting Group in Puerto Rico, said in an interview. "So that is the next shoe to drop."

Puerto Rico's 116 locally-chartered, regulated and insured credit unions hold $1.1 billion in Puerto Rico government bonds, according to José Sosa Lloréns, an attorney for 25 of the institutions.

Including credit co-ops, which provide a more limited selection of financial and banking options, the Puerto Rico government debt total increases to $1.5 billion, Calero said. Puerto Rico is also home to 11 locally-based federally chartered, regulated and insured credit unions that hold little of the debt.

The locally chartered credit unions are overseen by the Public Corporation for Supervising and Securing the Puerto Rico Cooperatives (known by the Spanish acronym COSSEC) while the federally chartered ones operate under the oversight of the National Credit Union Administration.

From 2009 to 2012 Puerto Rico had limited ability to sell its bonds in the bond market, so the government encouraged the locally-regulated cooperatives to buy its bonds, while it simultaneously held hearings about possibly eliminating the cooperatives' tax exemption. Some observers have said that the government effectively pressured the cooperatives to buy the bonds.

In the summer of 2015 Gov. Alejandro García Padilla said that Puerto Rico's $70 billion debt was unpayable under the prevailing economic conditions.

In order to protect the local credit unions from Puerto Rico's deteriorating debt situation, the government passed a law in December directing COSSEC to give the credit unions easier terms for treating its audited debt. Among other things, the law allowed the institutions to amortize their Puerto Rico bond losses over 15 years.

Leading local accountants consulted with the primary national trade organization, the American Institute of Certified Public Accountants, on the new law. In April they posted a notice to the web site of CPA College, which is based in Puerto Rico. Jorge Molina Montalvo, president of a COSSEC liaison committee and María Morales Hernández, technical advisor of the island's CPA association, said the December law "creates a gap between what is seen as right and what is right."

The accountants said that fellow members of their profession, when auditing the financial cooperatives, should rely on Generally Accepted Accounting Principles when determining whether there is doubt about the coop's ability to continue as a going concern in the following 12 months. If the audits follow GAAP, the co-ops' Puerto Rican bonds would have to be treated at market value. Up to now the co-ops have treated their holding of Puerto Rico bonds at face value.

"Investments of cooperatives in Puerto Rico bonds have resulted in an unrealized loss of more than $500 million, a figure that would exceed the capital of cooperatives," the Sin Comillas news web site said last month.

The locally-regulated co-ops have varying exposures to Puerto Rico government debt.

Making the matter more urgent, the co-ops were key purchasers of Government Development Bank for Puerto Rico notes. The co-ops own $599 million in GDB bonds and notes, according to Calero.

On May 2 the GDB failed to pay $370 million in principal it owed to a variety of debt holders. In the days leading up to the default the government reached a deal with the 25 co-ops represented by Sosa Lloréns to extend their GDB notes' maturity by a year and continue to pay interest.

Due to exposure to Puerto Rico debt, some local press accounts have estimated that 30 to 40 co-ops will go under.

Most co-ops' fiscal years run to the end of December, while some end on June 30. The co-ops' audits will be available three to four months later.

However, the audits' opinion of the locally-regulated co-ops may not be key to their future. How COSSEC deals with the co-ops will be much more important in determining whether they can continue or not, according to one CPA who spoke on condition of anonymity.

In Puerto Rico's latest restructuring proposal, the commonwealth has offered a par value option with low interest rates and very long maturities for island bond holders. This would benefit the co-ops, Feliciano said. They would have time to figure out how to adjust their income and could manage more easily knowing that the principal will ultimately be returned.

COSSEC insures the co-opdeposits up to $250,000. This insurance may prevent panic withdrawals from the co-ops, which would undermine them. However, it does not directly address their exposure to Puerto Rico's debt.

Sosa Lloréns said the co-ops were doing well. The co-ops have separate liquid reserves outside of their Puerto Rico debt of $2.15 billion and they have total assets of $8.47 billion. Their membership went up 17.6% from 2008 to 2015 and their assets increased 26.4% in the same period. He also said their return on assets were more than double those of the commonwealth's banks.

"In the past four years, the cooperative sectors have worked strategically to invest in the reconstruction of cash reserves to help mitigate the existing financial crisis owing to the island's public debt," said Puerto Rico Rep. Sonia Pacheco Irigoyen in an email.

Pacheco Irigoyen sponsored a bill aiming to protect the financial health of the co-ops. On Friday Gov. García Padilla signed the bill into law. The bill addresses what should be done if a receiver is used to wind down the GDB. It says that for unsecured debts, the co-ops should be given fourth priority.

According to a 1948 law the first three priorities are to pay the receiver, pay owed to the GDB employees for work done prior to the receivership, and benefits due to the employees. The fifth priority is GDB debts that are statutorily or contractually subordinate.

The governor sent out a release Friday saying giving the co-ops fourth priority was a step towards protecting the co-ops.

On April 29 the GDB released a statement saying that the co-ops would have to participate in any restructuring of the GDB's debt.

In another development concerning the locally-regulated co-ops, in late April COSSEC's board chose not to renew the contract of its executive director Daniel Rodríguez Collazo. COSSEC declined to comment for this story.

On April 15 National Association of Federal Credit Unions executive vice president Carrie Hunt said that any move by her organization to insure the deposits of the locally-insured Puerto Rico cooperatives "could expose the National Credit Union Share Insurance Fund to unacceptable financial risk and create serious reputational risk for the nation's federally insured credit unions." The National Association of Federal Credit Unions is one of two trade associations for federally-insured credit unions across the country.

The credit unions are not the only financial institutions hurting in Puerto Rico. S&P Global Ratings has given long-term creditor ratings of B-plus to First Bank Puerto Rico, BB-minus to Oriental Bank, BB to Banco Popular, and BBB-minus to Santander BanCorp, the island's four locally-based banks.

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