Puerto Rico Gov. Alejandro García Padilla, just past the halfway point in his first year in office, is touting his accomplishments – accomplishments that municipal analysts generally acknowledge.
“In only six months, we have tackled several key challenges faced by Puerto Rico for decades to protect our investment grade ratings,” García Padilla
Garcia Padilla cited the passage of “meaningful and comprehensive pension reform” and a fiscal 2014 budget that cuts the general fund deficit, as well as moves to restructure “fiscally strained” public corporations such as the Ports Authority, the Puerto Rico Aqueduct and Sewer Authority and the Highways and Transportation Authority.
“Decisive action has begun to restore the confidence of our people and of our investors,” Garcia Padilla concluded. “Puerto Rico is back on track and on the right direction.”
Analysts agreed for the most part, though they said Garcia Padilla still faces stiff headwinds in the coming year from a weakening economy that left the unemployment rate at 13.4% in May.
Pension Reform
In the winter of 2012-13 municipal analysts were generally united that major action was needed to address the underfunding of the Puerto Rico pension system. It had only 6 cents for every dollar actuarially required.
The Puerto Rican government said that if nothing was done, the fund was expected to run out of money in 2019, forcing the government to make large payments from its general fund.
In early April the García Padilla administration successfully pushed an overhaul through the Puerto Rico legislature that willrequire general fund contributions to the pension fund, but will keep them steady and moderate in size.
“The pension reforms enacted in April will not immediately change the optics of sub 10% funding levels, and this level may actually fall to near zero in coming years, but the reduction in pension related annual general fund expense will be very significant in coming years,” said Janney Capital Markets managing director Alan Schankel.
The pension reform was “a significant move for the finances of Puerto Rico,” said Oppenheimer Funds vice president Troy Willis. Puerto Rico went further in the reforms than those done by states and counties, he added.
The government is still planning reforms for other government pension plans, in particular the one for the elementary and high school teachers. The teachers’ pension is underfunded but not as badly as the main pension is.
Budget
Analysts said one of Garcia Padilla’s biggest challenges as he took office would be to end Puerto Rico’s longstanding track record of large deficits.
Prior governor Luis Fortuño had laid off many government employees in an effort to cut government spending. Fortuño inherited a deficit of $3.3 billion, said Puerto Rico Resident Commissioner and president of the New Progressive Party of Puerto Rico Pedro Pierluisi. The NPP is the main party in opposition to García Padilla’s Popular Democratic Party of Puerto Rico. By the time of Fortuño’s departure he was projecting a deficit of $1.1 billion.
When García Padilla came to power he said an inspection of the accounting books showed that the commonwealth’s finances were in much worse shape. He estimated that if no actions were taken, there would be a $2.2 billion deficit in fiscal 2013. He took measures to curb the deficit, whichMoody’s Investors Service estimates was about $1.3 billion.
In late April the governor unveiled a proposed budget that took a different approach from that of Fortuño, increasing tax revenues to pay for increased government spending.
García Padilla’s central tax revenue proposal was to introduce a business-to-business sales tax.
After negotiation in the legislature, this plan was scaled back to cover only a few business sectors. Instead, the additional revenues are expected to come primarily by increasing the tax rate on corporate profits and by introducing a tax on business revenues above $1 million a year. The plan also increased the Act 154 tax rate to 4%. Act 154 imposes an excise tax on certain acquisitions by non-resident individuals, corporations or partnerships of products manufactured in Puerto Rico and of services related to these products by entities affiliated with the purchaser.
The new budget projects a 7.9% deficit if debt service refinancing is included. This compares to a 13.1% deficit for fiscal 2013, which ended June 30.
“The new budget is pretty much what I was hoping to see,” wrote H.J. Sims senior vice president Richard Larkin. “The heavy lifting needed for tax increases was accomplished.”
“I don’t believe this budget should trigger a downgrade to non-investment grade,” Larkin wrote.
Other analysts, however, criticized the 7% increase in spending.When one has a major deficit one should not increase spending, Pierluisi said.
The major increase of taxes will harm the commonwealth’s economy, Pierluisi said. Since some of the taxes are new, Pierluisi said he had major concerns about whether they would be fully collected.
“Progress on budget and deficit reduction has been meaningful, although I am skeptical about realization of revenue projections, based on past history and the weak economy,” Schankel wrote. “If projected revenues are not realized at about mid-year and if mid-course remedial action is not taken, a downgrade is likely.”
Puerto Rico Highways and Transportation Authority
In late April the President of the Government Development Bank, Javier Ferrer, said that the Puerto Rico debt that most worried him was that of the Puerto Rico Highways and Transportation Authority. In particular, he said he was worried about the authority’s repeated operational gaps. The authority had turned to the GDB for loans to cover these gaps.
After a vigorous debate among many different parts of the executive and legislature, in late May the government approved three measures to increase the authority’s revenues.
The measures will shift $62 million per year in car license fee revenues to the authority. They will increase the petroleum products tax to $9.25 per barrel from $3, generating $189 million in additional annual revenue for the authority. Finally, they will transfer $30 million in annual cigarette tax revenues to the authority.
“The PRHTA loans had become a huge liability threatening GDB’s solvency and this last-minute revenue action [might have] avert[ed] large GDB loan write-downs, and potential downgrades, just two days before books close[d],” wrote Municipal Market Advisors managing director Robert Donahue in an e-mail.
The increased revenue for the authority will mean money for the GDB, Willis said. This will mean the GDB will be more flexible about where money can be lent. This is a good thing, he continued.
Schankel also praised the PRHTA revenue measures but said that he wanted to see the revenue projections realized.
Economy
Analysts all agreed that the Puerto Rico economy poses a central challenge for García Padilla in the coming months. The latest available data shows that the island’s May economic activity index was down 3.4% from a year earlier.
The government’s current main challenge is to improve the economy and reform the teachers’ pension, Barclays director of municipal research Tom Weyl said.
The economy grew for six or seven months in 2012, Pierluisi said. This was the first time it had grown in five years. Partly because a lack of confidence in García Padilla, the economy started to decline in December, Pierluisi said.
Because of the new administration’s tax increases and other choices, “I bet that this economy will not do well,” Pierluisi said. “I bet that the revenue projections will not be at what they projected.”
Schankel agreed that the economy “remains the largest concern.” If a revenue shortfall of around $1 billion were to occur in the current fiscal year, downgrades of Puerto Rico government credits to below investment grade are likely, he wrote.
Willis said Oppenheimer Funds expects little economic growth on the island in the next year.
García Padilla needs to expands his efforts to get major employers to open up major factories and offices in the country, Weyl said. Once one gets a commitment it still takes time for the establishments to open up and actually help the economy, he said.
