EMTA SPECIAL SEMINAR: PUERTO RICO: CRISIS AND OPPORTUNITY
Wednesday, June 25, 2014
360 Madison Avenue, 17th Floor
(on 45th St. between Madison and 5th Aves.)
New York City
Puerto Rico's creditworthiness has suffered a dramatic erosion, and there is a risk that the Commonwealth will be downgraded deeper into "junk" territory. In addition, banks in Puerto Rico have been weighed down by bad loans, thin margins, excessive reliance on wholesale funding, and the economic consequences of the government’s austerity measures. The solvency of a major bank has recently been undermined by the unilateral abrogation of a government tax-related liability, raising questions about the rule of law. This timely EMTA Special Seminar will provide a discussion of the investment and reform risks and opportunities that the crisis in Puerto Rico has generated.
11:45 a.m. Registration
12:00 noon - 2:00 p.m. Panel Discussion
James K. Glassman – Moderator
Arturo Porzecanski (American University)
Thomas Weyl (Barclays)
Doriana Gamboa (Fitch Ratings)
Matthew D. McGill (Gibson, Dunn & Crutcher)
Liam Localio (Greylock Capital Management)
Lunch will be provided
Registration fee for EMTA Members US$75 / US$695 for non-members / Credentialed Media Complimentary.
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Puerto Rican Debt Case Explored at EMTA Panel for Potential Precedents for EM Debt
Puerto Rico’s creditworthiness has suffered a dramatic erosion, and there is a risk that the Commonwealth will be downgraded deeper into “junk” territory. In addition, banks in Puerto Rico have been weighed down by bad loans, thin margins, excessive reliance on wholesale funding, and the economic consequences of the government’s austerity measures. The solvency of a major bank has recently been undermined by the unilateral abrogation of a government tax-related liability, raising questions about the rule of law.
This timely EMTA Special Seminar “Puerto Rico: Crisis and Opportunity” provided a discussion of the investment and reform risks and opportunities that the crisis in Puerto Rico has generated. The event was held on June 25 at EMTA’s offices in New York, and lunch was provided.
James Glassman moderated the panel, which included Arturo Porzecanski (American University), Thomas Weyl (Barclays), Doriana Gamboa (Fitch Ratings), Matthew McGill (Gibson, Dunn & Crutcher) and Liam Localio (Greylock Capital Management).
Mr. Glassman described Puerto Rico as the size of Oklahoma, with 3.7 million residents, acquired by the U.S. in the Spanish American War, a territory but treated like a state, that has fallen on hard times since 2004, with a major decrease in its work force and GDP (vs. an increase for the average of 13 other Caribbean countries), a 100% debt to GDP ratio (borrowing more than most, with the exception of New York and California), and with problems in attracting foreign business investment.
Mr. Weyl informed the audience of a recent government legislative initiative to appease the labor unions that would facilitate debt restructurings in state-owned companies, whose main objective was to minimize creditor holdout problems. Serious constitutional challenges to this legislation which could be mounted include the basis of its alleged violation of the takings clause and reserve powers issues. Ms. Gamboa confirmed that this law was also hurting local banks in an economy that has “major structural issues”.
Mr. Porzecanski likens Puerto Rico to a sovereign (Gamboa agreed), constrained by a currency and economic union with the mainland, that while it can’t print its own money has a bank (some may call it a “piggy-bank”) called the Government Development Bank (GDB). The new debt restructuring law is reminiscent of the case of Greece, when it unilaterally introduced CACs into its local-law debt contracts so they would be easier to restructure. The population is used to being looked after by the government, but the tax structure has recently been shifting in an unfavorable direction by a new tax on gross, rather than net, corporate income.
In response to Glassman’s query on what the U.S. government’s obligation is to step in if Puerto Rico defaults on its debt obligations, Porzecanski replied that a bail-out has never occurred before, but the U.S. could ask the IMF to step in and provide an assessment and evaluation of the island’s fiscal situation, something which other governments (e.g., the Netherlands and Portugal) have done in the past in connection with their overseas territories).
Mr. McGill reviewed the Doral Bank v. Puerto Rico Treasury Department case in which closing agreements signed by both parties in connection with tax disputes were reneged upon, such that Doral lost $900 million in regulatory capital relief. U.S. federal courts have no jurisdiction over these types of state tax matters. Meanwhile, Doral’s credit rating has decreased and it’s possible that the government will be reneging on many other similar contracts.
Mr. Localio was concerned that the government had not done enough to engage with its creditors, and specifically with its bondholders, and that this unwillingness to pay may turn into a case of repudiation. He didn’t think the U.S. was likely to intervene since Puerto Rico is unlikely to pose a systemic risk problem. Glassman suggested a potential contagion effect on the broader muni market, and Weyl and Porzecanski agreed that this is a risk that would cause “big waves” and should not be ignored.
Porzecanski predicted “there will be blood” coming out of the fragile fiscal situation, but he viewed this crisis as a constructive opportunity for the authorities in Puerto Rico to do the right thing, e.g. by enacting reforms of the bloated public sector, and by improving investment fundamentals, while cautioning that “reforming a welfare state is not the same thing as reforming a non-welfare state”. Gamboa suggested that a fix could not be accomplished overnight, but there was a stable outlook and banks were getting stronger. While 200 people a day were leaving the island, Glassman remarked that a Task Force on Puerto Rico had been set up by the Clinton Administration and was available to provide guidance, and that the territory has the potential to become “another Singapore”. Localio was digesting the implications of the new debt-restructuring framework, but thought there were still attractive trading opportunities for retail investors (such as triple tax-exempt debt), with smarter money going to physical assets like real estate. McGill noted the discount Puerto Rico has to suffer for its debt (vs. New York law-governed debt) as a result of the absence of faith in its rule of law and judicial structure. If Puerto Rico continues down this path of repudiating contracts, it will be much harder for it to gain access to the foreign investment that it needs.