Puerto Rico Oversight Board throws some cold water on bondholders' hopes

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The Puerto Rico Oversight Board delivered bad short-term and long-term news to bondholders at Tuesday’s meeting.

In the long term, the board approved a fiscal plan that projected that any central Puerto Rico government annual surplus available for paying debt will disappear in fiscal year 2034, even if all goes according to the board’s plans. As things currently stand, between surpluses in the years up to that date and deficits afterwards, the board expects a net $0 for paying debt other than that of the Puerto Rico Sales Tax Financing Corp. (COFINA).

The fiscal plan includes making payments of COFINA debt at levels found in a negotiated agreement with bondholders.

Three board members lamented that Puerto Rico’s legislature had failed to initiate structural reforms the board members would lead to greater economic growth. They mentioned the effort to improve the island’s labor participation rate by, in particular, passing an at-will employment law.

Board member Andrew Biggs said if the local government adopted additional structural reforms beyond the board’s capacity to impose, Puerto Rico could add 1% economic growth a year.

Board member Ana Matosantos said that she didn’t like the fiscal plan, that it doesn’t get rid of the budget gap, that it doesn’t restore growth, it “doesn’t free up money for creditors that some think it does.” Additionally, she said its cuts were too deep to social services and was too optimistic about generating federal aid.

Yet Matosantos said she’d vote for the plan “because it is foundational to the restructuring process and the development of a new budget.”

Christian Sobrino, Gov. Ricardo Rosselló’s non-voting member of the board, responded to the criticism of Biggs and board member Ana Matosantos by saying he was unsure why they were being so “grim.” The local government is doing well in terms of revenues and restructuring the government and debt, he said.

Additional bad news for bondholders in the short and long term is that the board continued to stick to the position that debt levels of U.S. states, rather than levels of surplus, should be the primary guides to the amount of debt the central government should pay.

In Tuesday’s meeting board Executive Director Natalie Jaresko said that the implied net tax capacity for fiscal years 2018 to 2023 for the central government would be $12.5 billion based the top 10 states for indebtedness or $4.2 billion based on the average of all 50 states. These are figures for total outstanding debt and not debt service levels. Jaresko said the figures should “inform future debt negotiations.”

For comparison, as of February 2017 Puerto Rico’s central government owed about $41.6 billion in debt, if one includes the COFINA debt.

The plan says that annual debt service should be capped at a “maximum annual debt service” level. This should be set with the aid of existing debt service ratios that compare states’ annual debt payments to annual revenues. The plan cites 4.5% as the average for the 50 states and 9.2% for the top 10 states.

To the extent that the surplus is below the maximum annual debt service for the year, than the surplus level should control debt payments. To the extent that surplus is above this level, the fiscal plan suggests one of three uses. One might be for contingent “growth bonds,” a second might be for debt service due on future new money borrowings, and a third could be for pay-as-you-go capital investments.

The board voted unanimously for the central government fiscal plan as well as for a fiscal plan for the University of Puerto Rico.

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PROMESA Commonwealth of Puerto Rico Puerto Rico Infrastructure Financial Authority Puerto Rico Employees Retirement System University of Puerto Rico Puerto Rico Sales Tax Financing Corp (COFINA) Puerto Rico Public Buildings Authority Puerto Rico Public Finance Corporation Puerto Rico