EMTA SPECIAL SEMINAR: PUERTO RICO: SCENARIOS FOR 2015
Friday, December 12, 2014
360 Madison Avenue, 17th Floor
(on 45th St. between Madison and 5th Aves.)
New York City
The authorities in Puerto Rico have faced a daunting task in order to stabilize the Commonwealth's creditworthiness: balance the government budget, improve the public sector's liquidity position, and get the island's economy growing again. The panel will discuss the extent of progress to date in these areas. What impact are these policy changes having on the economy’s fundamentals, and is the economy starting to recover?
What additional policy changes should be considered? Are concerns about the Commonwealth’s cash-flow and solvency situation being ameliorated? Is the ring-fencing strategy a correct one, and can the Commonwealth expect to pay off this debt? How likely is a default or preemptive restructuring during 2015? On the other hand, how likely is a significant rally in central government and development bank bonds? Is adequate information on the fiscal situation, debt and the economy available on a timely basis to evaluate Puerto Rico government risk? How is Puerto Rico risk priced relative to other below-investment-grade sovereigns?
What are the prospects for a default-free restructuring of state-owned agencies? What are the wider implications of the ongoing Doral Financial litigation? What interventions might the federal government consider to help Puerto Rico?
This timely EMTA Special Seminar will provide an update of the situation and a discussion of economic and financial scenarios for Puerto Rico in 2015.
11:45 a.m. Registration
12:00 noon – 2:00 p.m. Panel Discussion
Charles Blitzer (Blitzer Consulting) – Moderator
Joseph Rosenblum (AllianceBernstein)
Arturo Porzecanski (American University)
Aaron Stern (Fir Tree Partners)
Matthew McGill (Gibson, Dunn & Crutcher)
David Hitchcock (Standard & Poors)
Lunch will be provided
Support provided by Standard and Poors
For recent articles on Puerto Rico, Click Here.
Registration fee for EMTA Members US$95 / US$695 for non-members / Credentialed Media Complimentary.
Puerto Rico Seminar Stresses Road Ahead May Be Rocky, But Not Insurmountable
A discussion of Puerto Rico’s economic and financial situation, “Puerto Rico: Scenarios for 2015”, took place at EMTA’s offices in NYC on December 12, 2014. Charles Blitzer (Blitzer Consulting) moderated the panel, and other panelists included Joseph Rosenblum (AllianceBernstein), Arturo Porzecanski (American University), Aaron Stern (Fir Tree Partners), Matthew McGill (Gibson, Dunn & Crutcher) and David Hitchcock (Standard & Poors).
The authorities in Puerto Rico have faced a daunting task in order to stabilize the Commonwealth’s creditworthiness, which included balancing the government budget, improving the public sector’s liquidity position and getting the island’s economy growing again. The panel discussed the extent of progress to date in these areas, as well as other questions, including:
What impact are these policy changes having on the economy’s fundamentals, and is the economy starting to recover? What additional policy changes should be considered? Are concerns about the Commonwealth’s cash flow and solvency situation being ameliorated? Is the ring-fencing strategy a correct one, and can the Commonwealth expect to pay off this debt? How likely is a default or preemptive restructuring during 2015? On the other hand, how likely is a significant rally in central government and development bank bonds? Is adequate information on the fiscal situation, debt and the economy available on a timely basis to evaluate Puerto Rico government risk? How is Puerto Rico risk priced relative to other below investment-grade sovereigns? What are the prospects for a default-free restructuring of state-owned agencies? What are the wider implications of the ongoing Doral Financial litigation? What interventions might the Federal government consider to help Puerto Rico?
Mr. Blitzer led the panel by laying some of the groundwork – he explained that, while Puerto Rico (PR) has no Central Bank and takes orders from the US government, other sovereigns can learn valuable lessons from it. Its debt level is supported by taxes (40% to GDP, with low debt service costs) and, while it may have a liquidity problem, it will be awhile before that becomes an insolvency problem. He referred to a chart he prepared of comparable countries and raised a plethora of issues for the panel’s consideration – economics, debt, fiscal, governing issue and rule of law, state enterprises, policy recommendations and market pricing.
Mr. Hitchcock explained that S&P views PR as a territory subject to Federal law, with issues surrounding its ability to access the debt markets in the future, hence its BB rating. The potential for shortfalls in revenue, coupled by its willingness to pay (as evidenced by the Recovery Act), contribute to this rating.
Mr. Stern portrayed PR as a semi-sovereign with a complex capital structure, an investor base that is changing, and with general obligation bonds that are yielding upwards of 9%. Unlike states, PR has more control over its taxes and has exhibited support to increase them over time, as well as decrease its expenses. PR is trying to fix its public corporations and improve disclosure. Market price doesn’t reflect fundamentals or government actions to date.
Mr. McGill, representing two creditors of PR, Doral on a tax issue and BlueMountain on a US constitutional challenge to the Recovery Act, likened PR to Guam and DC (instead of a state), subject to plenary Congressional authority. Therefore, the current “no taxes on residents” and Federal transfer payments
to PR structures could change at any time, thus possibly decreasing PR’s general ability or willingness to pay its creditors. In fact, McGill views Doral’s behavior in nullifying its contracts as an unwillingness to pay and a willingness to walk away from its obligations, thus leading to a degradation of the rule of law.
Fortunately, while the Doral case was brought in a PR court, other cases against PR or its corporations may be brought in a Federal court and any judgments can be enforced in the US (unlike in the case of Argentina where assets could be moved to avoid payment on those judgments under a Foreign Sovereign Immunities Act rubric).
Mr. Rosenblum echoed earlier comments that PR was facing a liquidity and credit deterioration problem and that better disclosure was necessary. He viewed the Recovery Act as an “avoidance law” and felt that PR needed to convince its investors that it was truly investment-grade.
Mr. Porzecanski characterized PR’s actions as “patches” with “band-aid solutions”, with structural issues behind its fiscal situation that “won’t go away any time soon”. This was not a cyclical situation. Losing 20% of its population in the past 8 years (mostly attributable to young working adults) has had huge consequences and PR will have to scale down its services. Although he posits, “any crisis can turn into an opportunity”.
Responding to Blitzer’s query about whether PR’s comparability to sovereigns is too rosy, Rosenblum viewed the lack of economic growth, coupled with the exodus of the best young adults, as serious issues that should be addressed for PR as a whole (and that it was a mistake to analyze individual discrete corporate credits). Stern reminded the panel that the government has ring-fenced its public corporations through the Recovery Act (instead of using tax revenues) and that, while PR growth is low, it has never dipped and private sector employment has increased (as buttressed by a Fed article stating that jobs were increasing). And, while tax collections are low (vs. sovereigns and states), there is room to grow revenue. Moreover, PR’s need for money may parallel that of munis’, but it’s still relatively low and a good investment opportunity.
Hitchcock perceived speculative elements to the payment of debt, didn’t see restructuring as inevitable and continued to see risks with the government’s figures showing marginal growth (and questions as to how real growth is even calculated) and decreased employment and manufacturing. However, he viewed the situation as stabilized, although lacking clarity as to how the US recovery would impact PR. McGill claimed PR was different from sovereigns, as people were free to leave and go to Florida, with many educated young people moving to the mainland (thus masking the even greater unemployment rate if they did not do so).
Responding to Blitzer’s query about sustainability and the possibility of utilities’ bail-outs, Rosenblum viewed sustainability as key and McGill claimed that PR’s appetite for raising rates was low (as evidenced by its reluctance to increase the oil tax) and that the Recovery Act was not reasonable nor was the Prepa cram-down necessary. Stern believed that the Act passed to fill a void because PR was not eligible for Chapter 9 relief (in fact, Blitzer termed the Act the “Cleary Gottlieb version of Chapter 9”) and to separate out the corporations since PR did not want to use taxpayer funds to support the utilities. Porzecanski viewed the state-owned companies as of “a different era” with debt accumulations and budget deficits that couldn’t be privatized away. He hoped the business model would be changed, with a “new culture of payment” developing.
Responding to Blitzer’s query about what are the panelists’ top suggestions for increasing growth, as growth leads to greater investment, Hitchcock stated that most things are out of PR’s control (such as stronger growth in the US (since PR exports go to the US), decline in pharmaceuticals and manufacturing (with needed lower costs), decreasing oil prices and an increased minimum wage (a Fed issue)). Rosenblum suggested focusing on Prepa, more investment in plants and a quasi-private airport, attention to more spending and lower rates and the challenges with Medicaid. McGill cautioned that US direct investment in Prepa was utterly dependent on the rule of law, thus leading to a problem if there’s doubt as to whether PR will abide by its rules and contracts. The government needs to pay attention to how PR is perceived in the market, the culture of and respect for the rule of law needs to be advanced, and PR needs to rebuild its credibility and refrain from doing things that damage its credibility (like the Recovery Act enactment, FBI raids and repeated discussions with Congress). Stern pointed to the internationally accepted Nominal GDB data and statistics that show the striking increase in PR’s growth every year (without dips in growth, like the US had in 2008 and 2009), and he suggested that fixing the fiscal issues and the public corporations could help the economy grow.
Blitzer stated that, while PR’s current account was in surplus, PR was set in the mindset that’s behind the times and needs modernizing, with a tax system that needs reform in a fundamental way (too much revenue falls on too small a base). He asked the panelists what the US government could do to help PR. Hitchcock replied that the US could offer special tax breaks and avoid increasing the minimum wage. The rating agencies don’t currently assume US support, so if there was any it would be viewed as a positive. McGill suggested that extending Chapter 9 to PR would eliminate uncertainties as to the restructuring options available to Prepa, but cautioned that whatever Congress implements will come with oversight, “shining a bright light” on how things work. He also suggested that Congress look into GDB, which is currently unaudited and not regulated. Stern said that anything the US can do at the margin would be very helpful since the amount of money PR needs to fund its fiscal deficits is “shockingly low for its size”. Rosenblum doesn’t “hold hope” for the US to step in with funds and he reminds us that a control board was created for DC and Detroit was given funds for its municipality, not its creditors. Porzecanski encouraged PR to ask for US help since it’s highly likely that it would get it “without high consultancy charges” and that PR can do more than a “political third rail”. The “patient has to want to take the medicine [and] swallow [its] pride”. Its problems are structural and it needs more resources to deal with them.
Blitzer summarized the panel discussion: PR needs assistance with its “statistics mess” in redoing its books to show its investor base and help investors understand PR’s issues; it lacks a top-down approach and needs a macro conceptual advisory group; and it needs to increase productive growth and profit from any hearings in Congress as to how to turn PR around. PR’s issues can be solved, but PR needs to “think bigger and wider”. The growth model needs to be changed.