Dick Larkin, discusses these issues and more in today's  report on Puerto Rico Control Board

  • Adoption of a rescue law by Congress will not avert July 1 defaults;
  • The law provides for a control board, and states that no taxpayer funds are spent in the bill;
  • The control board may not be finalized as late as December 1, allowing Puerto Rico  to continue overspending;
  • The section on adjusting debts is modeled after US Code Chapter 11 bankruptcy laws;
  • Sections of the report seem to favor constitutionally protected debt like general obligation bonds;
  • The law implies that essential services and pensions will require debt reductions by investors after all other priorities; and
  • The law is written so that it could be applied to other territories (e.g., Guam & the Virgin Islands), if economic and financial assistance are requested.

Whatever Is Approved by Congress, More Defaults On July 1 Are A Certainty

A new bill to rescue Puerto Rico from its debt crisis, was put on a House Sub-Committee agenda for debate.  Even if that House of Representatives sub-committee agrees to send the bill to the full House, no one knows if Congress will or will not pass federal legislation regarding Puerto Rico’s debt crisis.  But judging from weeks of remarks from congressmen, they tell us three things that are sure:

  1. There will be a federal oversight “Control Board” that can direct Puerto Rico’s budgets and finances;
  2. there will be NO federal bailout of Puerto Rico that involves taxpayer money; and
  3. The Control Board will have the power to decide which debts will be paid in full, or which debts will only be paid partially, or not at all.

Here’s the uncertainty:  politicians are discussing the need to pass legislation in order to avert default.  There is talk of giving the new Control Board the power to allocate, negotiate and legislate changes in the term of investors debt.  If this is an outcome, the legislation wouldn’t pay debts on July 1; it would just create an authority with legal authorization to reduce or skip debt payments.

In a statement last week regarding the pending defaults on $2 billion of debt, including $800 of constitutionally-protected General Obligation debt, Governor of Puerto Rico indicated that “As of today, I don’t think we will be able to come up with an idea to have that money.”  Is the Governor “bluffing” to put pressure on Congress for a relief bill?  Because even if the bill is voted in full by Congress by July 1, there would probably not be enough time to choose and approve members to the board, nor would it be able to have professionals hired in time to act before July 1.  Finally, without additional federal money (not gonna happen), how will a control board help avert a big default on July 1 (unless the Governor is “bluffing”)?

The control board piece of the legislation should be welcomed by investors; it is clear that the Commonwealth does not have the self-discipline to operate with balance budgets.

However, 29 of the 148 pages of draft legislation deal with the rules for “adjusting” debts (translation: default).  In this respect, the Puerto Rico Oversight, Management & Economic Stability Act (PROMESA) outlines how the control board can adjust debts to investors.

In this respect, the bill as currently drafted is a “bankruptcy code”, without the official designation “bankruptcy”.  In fact, pages 70-75 use copies and wording of Chapter 11 bankruptcy sections as a guide for dealing with adjusting debts in Puerto Rico.

There are two troubling aspects of the report.  First, there is duplicative language in several areas of the report that state that debts will be reviewed after “relative lawful priorities…in the (Puerto Rico) constitution.  That would appear to give priority consideration to General Obligation (GO) bonds and COFINA Sales tax bonds.  And on page 36, any approved fiscal plan needs to cover these goals, while preserving Puerto Rico’s ability to access the market:

  1. Accurate estimates of revenue/expenditure conforming to standard accounting rules;
  2. Fund essential services
  3. Adequate funding for pensions;
  4. Eliminate structural deficits;
  5. Provide a “sustainable debt burden.

As we’ve seen in other distressed governments like Detroit and Jefferson County, Alabama, the payment of essential services will be placed before payments on debt.  In Puerto Rico, that could occur on July 1, despite constitutional protections on G.O. bonds.

It is ironic that the bill is titled “PROMESA”, which is translated in to English as “promise”.  Ironic because the bill would unilaterally break “promises” made over several years, involving billions of dollars to investors, many of which invested their retirement funds in Puerto Rico.

Dick Larkin
Director of Credit Analysis
Stoever Glass & Co. Inc
 P: (800) 223-3881
E: dlarkin@stoeverglass.com

05/25/2016 | Dick Larkin, discusses these issues and more in today's report on Puerto Rico Control Board
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