Alvin Baez/ReutersA closed shop in San Juan.

While Detroit has preoccupied Americans with its record-breaking municipal bankruptcy, another public finance crisis on a potentially greater scale has been developing off most Americans’ radar screens, in Puerto Rico.

Puerto Rico has been effectively shut out of the bond market and is now financing its operations with bank credit and other short-term measures that are unsustainable in the long run. The biggest concern is that the territory, which has bonds that are widely held by mutual funds, will need some sort of federal lifeline, an action for which there is no precedent.

In a meeting with bond analysts in New York on Monday, the president of the Puerto Rican Senate, Eduardo Bhatia, said officials in the United States Treasury and White House had been analyzing the situation carefully, “wondering how they can help Puerto Rico send a very strong signal of stability right now.”

“We are waiting for some sort of an announcement from the Treasury and the White House,” he said without clarification. He also complained that analysts and investors did not appreciate the tough austerity measures that Puerto Rico pushed through in recent months.

See – http://bloom.bg/1fg47RH

Puerto Rico, with 3.7 million residents, has about $87 billion of debt, counting pensions, or $23,000 for every man woman and child. That compares with about $18 billion of debt for Detroit, with a little more than 700,000 people, or about $25,000 for every person in the city. Detroit and Puerto Rico have been rapidly losing population, leaving a smaller, and poorer, group behind to shoulder the burden.

Detroit, at least, was able to seek relief in bankruptcy court, but Puerto Rico is in a legal twilight zone. Territories, like states, have no ability to declare bankruptcy. Another territory, the Northern Mariana Islands, tried in 2012, but its case was rejected. Top Puerto Rican officials say that the territory is not bankrupt and is working through its problems responsibly. To show their good intent, the governor, Alejandro Garcia Padilla, and members of his government have been shuttling to New York and Washington in recent weeks, meeting with bankers, credit analysts, members of Congress and Treasury officials, providing details of the fiscal changes they have pushed through and discussing what else might be needed.

“These guys down in Puerto Rico, they’re determined to make this work,” said Alan Schankel, a managing director at Janney Capital Markets, who recently visited the island.

But the coming weeks will be critical, and how Puerto Rico comes through depends, to some extent, on factors beyond its control. If its financial problems worsen, it may need some form of sovereign debt relief for which there is no direct precedent — and that would probably be subject to approval by a Congress now paralyzed and focused on a fiscal situation closer to home.

“A lot of people believe that the Territorial Clause of the United States Constitution gives Congress the power to impose control,” said Robert Donahue, a managing director with Municipal Market Advisors, who has been discussing the situation with members of the President’s Task Force on Puerto Rico, a group representing 16 cabinet-level agencies and the White House.

One idea being considered is that Congress might establish a financial control board, perhaps like the one that helped guide the District of Columbia through a turbulent period from 1995 to 2001. One of that board’s first steps was to appoint a financial official with power to override the mayor and City Council.

But with the federal government shut down, Mr. Donahue said, “there’s really no path.”

Despite its uncanny similarities to Detroit, Puerto Rico got into trouble in a sharply different way. Detroit owes the bulk of its debt to retired city workers, in the form of unfunded pensions and promises to provide health care. Puerto Rico has also made big pension promises, but the bulk of its debt is owed to investors that hold its bonds.

Until a few months ago, Puerto Rico was the belle of the bond markets. As a territory, it can sell bonds that pay tax-exempt interest in all 50 states, a rare and desirable trait. Puerto Rico’s bonds also pay higher interest than many others because its credit rating is relatively low — but not low enough to scare off investors. Some of its bonds were insured against default; others have special legal structures that make them seem bulletproof. The territory’s constitution explicitly states that general bond obligations have first call on all available resources.

Because Puerto Rico’s bonds have these unusual advantages, investors snapped them up year after year, even as the territory’s overall debt load started to snowball. In each of the last six years, Puerto Rico sold hundreds of millions of dollars of new bonds just to meet payments on its older, outstanding bonds — a red flag. It also sold $2.5 billion worth of bonds to raise cash for its troubled pension system — a risky practice — and it sold still more long-term bonds to cover its yearly budget deficits.

Mutual funds in particular were eager buyers; by adding Puerto Rican debt to an otherwise ho-hum portfolio, they could lift the overall yield without seeming to add much risk.

That cycle — a bountiful supply of debt feeding a seemingly insatiable demand — sputtered to a halt this summer, leaving Puerto Rico with more debt than it can easily pay. Its government must still borrow to finance its operations. Now it will cost much more to do so.

The Federal Reserve’s signals earlier this year that it would ease its stimulus measures spooked the bond markets. Most states and cities have kept soldiering along, but the shocks left Puerto Rico effectively unable to borrow on the public markets.

In September, mutual funds and other institutions began to sell big blocks of its bonds, driving their prices down. That led to buying by hedge funds hoping to profit on a possible restructuring.

After the yields on Puerto Rico’s outstanding bonds rose higher even than Greece’s, José V. Pagán, the interim chief of the Puerto Rican Government Development Bank, announced that the territory would postpone most long-term borrowing for the rest of 2013. For now, he said, Puerto Rico would rely mainly on bank credit and private placements of short-term notes.

The three main ratings agencies have held Puerto Rico’s general-obligation debt one notch above junk, despite the deterioration of the last few weeks. After the spate of selling in September, yields on its debt now correspond to those of speculative bonds.

“We found the actions that the government took credible,” said Lisa Heller, a lead public-finance analyst at Moody’s Investors Service. She said she wanted to see how well the government’s reforms would take hold, given the difficulty of raising taxes and utility fees in a weak economy.

A one-notch downgrade would officially send Puerto Rico’s general debt into junk territory, with troubling consequences. Puerto Rico, like Detroit and numerous other localities, is party to financial contracts known as interest-rate swaps, which require it to post cash collateral if its credit falls below investment grade. In addition, mutual funds and other institutions might have to sell their Puerto Rican holdings if they lose their investment-grade ratings. That could set off another damaging run.

Ricardo Arduengo/Associated PressPuerto Rico has had an exodus prompted by financial woes, which Gov. Alejandro Garcia Padilla and other officials say they are addressing responsibly.

Puerto Rican officials argue that the markets do not appreciate the tough fiscal changes that Governor Garcia Padilla has made since taking office in January. He has frozen the biggest of the island’s public pension funds, raised utility rates sharply, imposed new taxes and stepped up enforcement of existing taxes.

“I do not know a single state government, a single municipal government, that within six months of being elected undertook this amount of reforms,” Mr. Bhatia told the analysts’ group on Monday.

“I thought that in September I was going to come to New York and open a glass of Champagne with investors,” he said, but instead, the analysts seemed to ignore all the government had done and demanded more.

Analysts at the meeting told Mr. Bhatia they had been following Puerto Rico’s economy for many years and had heard previous administrations talk of great reforms, only to see deficit spending and borrowing continue.

“This time is different because we have approved the legislation that you have asked us to approve,” Mr. Bhatia said, citing the pension overhaul and the sale of the island’s biggest airport to private investors. The changes were “unparalleled to any reforms that I have seen in Puerto Rico over the last 30 years,” he said, “and we are paying a very serious political price for it in Puerto Rico.”

“I’ll be blunt — we are frustrated,” he said. “We are slowly, slowly seeing the initial results, the short-term results of our reforms. We need some breathing room. Puerto Rico is certainly doing its part.”

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http://www.globalpost.com/dispatch/news/thomson-reuters/131007/puerto-rico-expects-get-federal-economic-incentives-bhatia

Thomson Reuters

October 7, 2013 16:32

Puerto Rico expects U.S. economic incentives: Bhatia

(Globalpost/GlobalPost)

By Edward Krudy

NEW YORK (Reuters) – Federal officials are expected to announce incentives to boost Puerto Rico’s economy in the next few months, a top legislator from the commonwealth said on Monday, responding to investor concerns about the island’s rising debt costs and bleak growth.

The help is unlikely to include direct financial aid, Puerto Rico Senate President Eduardo Bhatia said at an investor gathering in New York. He did not provide specifics.

The assistance would come in response to the last four years of recession in the Caribbean territory, Bhatia said. It has been given added urgency due to a spike in Puerto Rico’s debt yields in the recent months, he said.

The selloff in Puerto Rico’s bonds has been driven by worries about the territory’s shrinking economy, its high jobless rate and per capita debt, which are far higher than that of any U.S. state. The U.S. commonwealth’s unemployment rate is nearly 14 percent, higher than any U.S. state.

«We are waiting to hear an announcement from the Treasury and the White House. We know for a fact they have been very aggressively thinking of how to be sure that they can help Puerto Rico send a very strong signal of stability right now,» Bhatia told the meeting.

Puerto Rico has about $70 billion of outstanding debt, or nearly 2 percent of the overall $3.7 trillion municipal bond market. That dwarfs the $18 billion held by Detroit, which roiled the muni market when it filed for municipal bankruptcy earlier this year.

Puerto Rico’s debt is held widely by mutual funds, increasing the systemic risk. The island will not be entitled to Chapter 9 municipal bankruptcy.

Puerto Rico’s debt costs have soared this year. In May, 30-year general obligation bonds carried a yield of about 5.3 percent and hit a peak of 8.6 percent in mid-September. The debt is now trading with a yield of 8.1 percent, which is far higher than any U.S. state’s. Puerto Rico’s debt is rated BBB, one notch above junk.

ECONOMIC REFORMS

Officials in San Juan have embarked on economic reforms intended to show that the Caribbean territory will pay its debts, Bhatia said, citing pension reform, changes to tax laws and a reduced government work force.

Bhatia expressed frustration that investors appeared not to have recognized the reforms, and instead are punishing Puerto Rico with higher borrowing costs.

«The kind of reform you are making us do is very tough,» Bhatia said. «But we are doing it because we want to send a signal that we are honoring our debt.»

Bhatia said even if Puerto Rico were in danger of defaulting, the commonwealth’s constitution stipulates that bond holders are paid before pensioners and government workers. He cited the 2006 crisis in which Puerto Rico’s bond holders were paid while government workers were not.

Economic development officials and Puerto Rico Governor Garcia Padilla have been in talks with the U.S. Treasury and White House, he said.

A Treasury spokesperson told Reuters on Monday that the Treasury was monitoring the situation but would not discuss where the monitoring would lead.

«Given the potential for Puerto Rico’s financial challenges to impact United States markets, including the municipal market, Treasury continues to closely monitor developments,» said the spokesperson, who did not want to be named.

A senior White House administration official said President Barack Obama’s task force on Puerto Rico has been «working for a number of years to maximize the impact of federal resources on the island.

«As part of its ongoing work, the task force is coordinating with federal agencies to strengthen Puerto Rico’s fiscal situation and economic outlook,» the official said.

Although details about any federal action were thin, analysts at Bank of America Merrill Lynch pointed to a $320 million aid package the Obama administration agreed to for Detroit to help with infrastructure development. In the case of Detroit, a large portion of the aid, which comes from federal, state and private sources, was previously earmarked for the city but delivery was slowed by red tape and other issues.

As one economic development tool, Bhatia noted tax breaks that some U.S. companies once enjoyed in Puerto Rico.

Federal authorities phased out tax breaks for parent companies of Puerto Rico-based U.S. manufacturers at the end of 2006. Puerto Rico entered a recession that year and has yet to recover.

There have been some positive signs from Puerto Rico’s economy. Tax revenues for the three months through September rose by $70 million, or 4.4 percent, to a provisional $1.68 billion, the island’s treasury secretary said on Monday. Bhatia attributed the gain to recent tax reform.

(Additional reporting by Lisa Lambert in Washington; Editing by Tiziana Barghini and Dan Grebler)

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