Puerto Rico’s Fiscal And Economic Crisis by Commonwealth of Puerto Rico

Economic Decline of Puerto Rico

Since the expiration of Section 936 of the US Internal Revenue Code in 2006(1) and the onset of the global financial crisis in 2007, the Commonwealth has faced virtually continuous economic decline nothwithstanding substantial stimulus spending

  • GNP growth has been negative nearly every year since FY 2007; little growth was recorded in the prior decade
  • The lower rate of GNP decline since FY 2009 is due in large part to the significant stimulus and deficit spending injected into Puerto Rico’s economy during the same period
    • For example, the Commonwealth was allocated approximately $7.1 billion of funds through the American Recovery and Reinvestment Act (“ARRA”) and, using the Puerto Rico Sales Tax Financing Corporation (“COFINA”) bond proceeds from offerings in 2009 and 2010, the Commonwealth created a $500 million “Local Stimulus Fund”
    • Furthermore, tax reform enacted in 2011 sought to jumpstart the economy by reducing individual and corporate taxes by approximately $706 million, some of the provisions of which were later modified to deal with resulting revenue shortfalls

Puerto Rico

Deteriorating Economic Prospects & Demographic Trends

Reduced economic activity has had a marked effect on the residents of the Commonwealth, leading to stagnating incomes and increasing outmigration to the mainland

  • As multinational corporations left the Commonwealth following the expiration of Section 936 and without substantial job creation, cumulative per capita income growth of 5.5%(1) from 2006 to 2013 has failed to keep pace with cumulative inflation of ~15%(2) over the same time period
  • Deteriorating economic conditions have therefore led many Puerto Ricans to emigrate to the mainland
  • The Commonwealth average net outmigration was approximately 48,000 residents per year from 2010 to 2013(3), with 42% of emigrants citing their primary reason for moving as job-related; in 2013, approximately 74,000 residents emigrated to the mainland(4)
  • The remaining population is becoming increasingly elderly and, as a result, a higher percentage of the population is outside the labor force
    • Persons 60 years and older represent more than 20% of the population (the highest in the United States) and their labor participation rates range from 10.7% to 13.3%(5); children aged five years or less have decreased from 295,406 in 2000 to approximately 187,371 in 2014, a reduction of 37%(6)

Puerto Rico

The Commonwealth Implemented Significant Austerity Measures to Strengthen its Finances

The following chart represents a select subset of the various measures that the Commonwealth has taken since the onset of the economic crisis

Puerto Rico

Commonwealth Expects To Have Insufficient Liquidity to Make Upcoming Debt Service Payments

Absent extraordinary and unsustainable liquidity measures taken by the Commonwealth, the TSA would have already exhausted its cash; TSA expected to have insufficient cash to make its GO debt service payments in June

Puerto Rico

Puerto Rico’s Debt Load is Unsustainable

The Fiscal and Economic Growth Plan (“FEGP”) developed by the Working Group for the Fiscal and Economic Recovery of Puerto Rico shows that significant contributions in the form of expense and revenue measures, structural reforms and a substantial debt restructuring are necessary to put the Commonwealth on a path to long-term sustainability and enable it to continue providing essential services to its citizens

  • As shown in the updated FEGP published January 18, 2016, based on the Commonwealth’s current fiscal policies, growth trends and existing debt service schedule, the Commonwealth projects a cumulative fiscal deficit of $63.4 billion over the next ten years
  • To address this deficit, the Working Group developed extensive revenue and expense measures, projected to result in approximately $20.6 billion and $13.8 billion of benefits, respectively, which would reduce the fiscal deficit to approximately $34.0 billion, before considering any incremental economic growth benefits
  • With approximately $33.0 billion of scheduled principal and interest payments due over the next ten years,(1) a substantial restructuring of the Commonwealth’s existing debt is required to allow the Commonwealth to bring its fiscal accounts into balance, to give it time and the financial flexibility to implement the FEGP’s structural reforms and growth initiatives so as to stimulate the Puerto Rican economy and thereby to make the restructured debt sustainable in the long term

Puerto Rico

Puerto Rico’s Debt Load Is Significantly Higher than Any U.S. State and Cannot Be Sustained

Under the proposed exchange, the Commonwealth’s debt service-to-revenue ratio would be significantly reduced, but would remain at levels above the most indebted U.S. states.(1) However, debt service under the Base Bond is structured to allow the Commonwealth to grow into a stronger credit over time

  • The ratios as calculated by Moody’s include all tax-supported debt of the states, and are calculated on a basis that is generally comparable with the tax supported debt included in Puerto Rico’s FEGP
  • On each metric, the Commonwealth before any restructuring is significantly worse than the worst state. The proposed restructuring would improve Puerto Rico’s metrics and put the Commonwealth on a path to sustainability; however even after a restructuring, Puerto Rico’s metrics will still be worse than each of the 50 U.S. states

Puerto Rico

The Commonwealth’s Proposed Restructuring Plan Makes its Debt Load Sustainable

In order to confront the significant shortfalls in the FEGP, even after the implementation of all revenue and expense measures contemplated in the FEGP, the Working Group and its advisors have developed a voluntary debt exchange that would provide Puerto Rico with necessary debt relief

  • In order to facilitate an orderly restructuring of its debt, the Commonwealth has designed an exchange offer to holders of its $49.2 billion of tax-supported debt(1)
  • The restructuring contemplates that creditors will agree to exchange their existing securities for two new securities: a “Base Bond,” with a fixed rate of interest and amortization schedule, and a “Growth Bond,” which is payable if the Commonwealth’s revenues exceed certain levels; under this proposal, the $49.2 billion of taxsupported debt would be exchanged into $26.5 billion of new mandatorily payable Base Bonds and $22.7 billion of Growth Bonds
  • The proposed structure contemplates no interest payments until FY 2018 and no principal payments until FY 2021, which would provide the Commonwealth with the necessary debt service relief to be able to continue to provide essential services to its residents, repay stretched suppliers and taxpayers, rebuild depleted cash resources and properly fund the retirement system; additionally, it will allow the Commonwealth to implement the measures outlined in the FEGP
    • Additionally, the new securities are projected to provide the Commonwealth with a sustainable level of debt service over the long term, as total debt service will only increase if the Commonwealth’s revenues grow
  • The voluntary exchange offer is based on an initial debt service-to-Adjusted Revenues(3) ratio of approximately 15%, which is significantly below the current ratio of 36% and would result in a sustainable capital structure over time
    • The highest U.S. state has debt service to Adjusted Revenues of 13%
    • Exchange offer would also require the Commonwealth to comply with a debt service-to-Adjusted Revenues ratio of 15% before issuing additional tax-supported debt
  • To the extent the Commonwealth economy grows, the ratio of debt service to Adjusted Revenues would decline over time
  • The Commonwealth economy is experiencing negative real GNP growth, and therefore, the proposed exchange contemplates the Commonwealth would take on the risk that implementation of the FEGP may take longer to have a positive impact on economic growth and, by extension, Commonwealth revenues
  • If the Commonwealth achieves 2.5% real economic growth, a rate consistent with the midpoint projected growth for the mainland U.S., the face amount of the Growth Bond will be paid in full over its 35-year term
    • For the Growth Bond to be payable, total payments on the Base and Growth Bonds in any year may not exceed 10.5% of Adjusted Revenues(1)

Restructuring Would Reduce Debt Service and Enable Creditors to Recover Full Principal if Economy Grows

The below illustrates the pro-forma debt service schedule and the allocation of new securities under the proposed restructuring

Puerto Rico

See full slides below.