In the second year of Puerto Rico Gov. Alejandro García Padilla's administration, there was plenty of news from the commonwealth for municipal bond investors to digest.
In January the government started to shift up to $2.8 billion in government deposits to the Government Development Bank for Puerto Rico from private banks to increase the GDB's liquidity.
Also in January the governor met with the island's mayors and backtracked from a plan to decrease the commonwealth's sales tax to 6.5% from 7%. The government had anticipated reducing the 1.5% sliver for the municipalities to 1%. In an agreement with the mayors, it was decided that the cities would continue to get 1.5% and the commonwealth would continue to get 5.5%. However, the mayors made a concession to the commonwealth. Whereas before only the commonwealth's 5.5% first passed through the Puerto Rico Sales Tax Financing Corp. (COFINA), now a 0.5% portion of the cities' 1.5% slice would also pass through COFINA.
When the governor came to power in January 2013 the ratings agencies asked him to submit a balanced budget for fiscal year 2016, García Padilla said. At the end of January he promised he would submit a balanced or near-balanced fiscal 2015 budget, which would start July 1, 2014. The governor boasted of moving twice as fast as the ratings agencies had asked.
As of late December 2014 data indicated that the fiscal year 2015 budget is near revenue and spending projections.
While nominally balanced, the budget is dependent on capitalized interest. Taking this into account, it is anticipated there will be a 2.8% deficit this fiscal year, an improvement from the 13.1% deficit in fiscal 2013.
In February, the three ratings agencies downgraded Puerto Rico's general obligation and most of its other bonds to speculative grades. The public corporation bond ratings were also dropped to speculative grades at this time. To the extent one could fairly group all the Puerto Rico issuers together, the downgrades made Puerto Rico the largest speculative grade issuer in United States history by par value outstanding.
In late February the Puerto Rico Supreme Court largely upheld the governor's judicial pension reform.
In mid-March Puerto Rico sold a $3.5 billion 21-year GO bond, the largest speculative grade municipal bond issued in United States history, with an 8.73% yield to maturity. The commonwealth used the money to refinance short-term debt and other obligations, swap termination payments, and give the GDB a liquidity boost.
After the good news of the successful sale, the governor got bad news in April when Puerto Rico's Supreme Court struck down the teachers' pension reform that the government had passed in December.
In May, the government announced its April revenues had come in 26% under projections. On July 1 the fiscal year 2014 closed with revenues 5.1% below budget. However, due to cuts in expenditures not originally budgeted and made in the winter and spring of 2014, the deficit came in slightly smaller in dollars than budgeted.
In late June at García Padilla's request, Puerto Rico's government adopted the Special Law for Government Fiscal and Operational Stability. This instituted emergency measures to restrain government spending and made possible the adoption of an at least superficially balanced budget.
In very late June the government adopted the Puerto Rico Public Corporations Debt Enforcement and Recovery Act, opening two possible bankruptcy options for four public corporations. García Padilla presented the law as a step to ring-fence the commonwealth government from any problems at the corporations.
Initially investors agreed and prices on Puerto Rico GO bonds rallied. After a few days, muni investors and the rating agencies were becoming more negative about the changes. In July the three major raters further downgraded Puerto Rico's GO bonds.
Meanwhile, there was increasingly troubling news concerning one of the eligible public corporations, Puerto Rico Electric Power Authority. On July 1 Fitch Ratings dropped PREPA's power revenue bonds to CC and said that a default was probable. On July 10 PREPA announced on Electronic Municipal Market Access that it had drawn on its debt service reserve to help it make a $418 million debt service payment on July 1.
In mid-August PREPA announced it had entered into a debt forbearance agreement with more than 60% of its bondholders. The agreement, among other things, indicated that PREPA would provide a debt restructuring plan on March 2, 2015.
Meanwhile, García Padilla was working on steps to financially strengthen the Puerto Rico Highways and Transportation Authority and prevent it from needing to default on its bonds. Ultimately the Puerto Rico legislature passed a version of an oil tax hike with a bond sale by another authority that would get the PRHTA off the hook for $2.2 billion. The governor was and remains not fully pleased with this bill and is hoping to get a better version passed for his signature in mid-January.
Meanwhile, Puerto Rico's Treasury Department has been working on what many expect to be the commonwealth's biggest tax reform in several decades. According to the current plans, the threshold for paying any income taxes in Puerto Rico would rise. To make up for this, the current 7% sales tax would be replaced by a 14% to 16% value-added tax. A credit for low income households would be introduced to undo the regressive nature of consumption-based taxes.
Hovering over all these developments has been Puerto Rico's continued weak economy. From November 2013 to November 2014 the GDB's economic activity index was down 2.1%.
However, there have been some positive signs recently. The index has gone up for three consecutive months on a month-to-month basis. November's unemployment rate was 1.2 percentage points lower than a year earlier. And the United States Bureau of Labor Statistics establishment survey showed that private sector employment was up for the 13th consecutive month on a year-over-year basis in November.
