A preliminary review of recently released audited financial statement data reveals widespread financial distress among Puerto Rico’s 78 municipalities. Several of these local governments may require extraordinary financial assistance from the Commonwealth, raising the possibility that a significant portion of Puerto Rico’s $4 billion in municipal debt could become a concern for holders of Puerto Rico general obligation bonds. Another possibility is that several of the municipalities will file for bankruptcy protection should Congress choose to extend the Chapter 9 option to Puerto Rican entities.

The financial data was obtained by Centro de Investigaci-n y Política Pública (CIPP), a Puerto Rico-based not-for-profit that operates the government transparency site ABRE Puerto Rico (Open Puerto Rico). The financial statements as well as summary statistics will be posted on ABRE Puerto Rico by late April. We have been able to examine some of the data ahead of this release, and are sharing some key findings in this note.

Puerto Rico municipalities file audited financial statements with the federal and Commonwealth governments. Any U.S. local government that receives at least $500,000 in federal funds is required to file a single audit each year. It appears that all 78 Puerto Rican municipalities – including those with less than 10,000 in population – meet the filing threshold. The reports are in English, are presented in accordance with GASB standards, and contain opinions from third party auditors. In most cases, CIPP was able to obtain filings for the fiscal year ended June 30, 2013; but in some cases 2012 filings were the latest available.

According to summary data obtained by CIPP and spot-checked by this author, more than half of Puerto Rico municipalities have negative general fund balances. Few cities meet the GFOA recommendation for fund balance, i.e. enough to cover two months of spending. The Commonwealth’s largest city, San Juan, reported a positive general fund balance of $11 million – just over 2% of annual expenditures – but none of this money is available for discretionary spending. After subtracting the $110 million in Nonspendable and Restricted General Fund balances, San Juan is left with an Assigned and Unassigned General Fund balance of negative $99 million.

A majority of cities also experienced general fund deficits in fiscal 2013, digging themselves deeper into insolvency. For example, San Juan recorded general fund revenues of $420 million versus expenditures of $470 million. Ponce, the territory’s fourth largest city, has run substantial deficits during each fiscal year since 2008, accumulating a negative general fund balance of $36 million. This level of accumulated general fund deficits is comparable to that reported by San Bernardino in the wake of its 2012 bankruptcy filing.

Not all Puerto Rico cities are experiencing fiscal distress. Carolina, the third largest city, reported a roughly balanced budget in 2013 and significant unrestricted general fund reserves. Bayamon, the number two city, had a 2013 surplus and a positive assigned/unassigned general fund balance but reported a negative unrestricted net position on its government-wide statement of net position.

Some smaller municipalities reported alarming results, and perhaps should have received “going concern” audit opinions. One example is Maunabo, a 12,000-resident municipality on Puerto Rico’s southeast coast. As of June 30, 2012, the municipality had a general fund balance of negative $2.9 million. That worsened to negative $3.5 million as of June 30, 2013.

Most of the Maunabo’s revenue comes from the Commonwealth or Federal government. In fiscal 2013, the city had total revenues of $14.4 million of which $11.2 million took the form of intergovernmental grants and subsidies. Since the community lacks the ability to support the level of service provided by the local government, spending cuts at either the federal or Commonwealth level could be devastating.

The auditor found problems with how Maunabo accounts for its USDA Community Development Block Grants, which, at $1.7 million, is the largest federal grant it receives. The most serious finding was that “the Program did not maintain accurate accounting records of the financial transactions and did not reconcile, the cash account with the quarterly reports submitted to the pass-through-entity (which is OCAM – the Office of Commissioner of Municipal Affairs).”

The auditor also gave a qualified opinion of Maunabo’s financial statements because the city does not have “complete, updated and accurate records of [it’s] capital assets.” Footnotes to the financial statements reveal that the city has overdrafts in its bank accounts and that it has missed $400,000 in interest and principal payments on a 2006 Department of Housing and Urban Development loan. These defaults have been covered by OCAM.

Several other small municipalities had audit exceptions, negative general fund balances and/or a majority of revenues from intergovernmental sources. Unless Puerto Rico experiences an unexpected turnaround, these municipalities will be unable to service their substantial debts without extraordinary assistance from higher levels of government.