In the realm of municipal bonds, the enormous problems facing Puerto Rico are well-known: part Greece, part California, and part dodo bird. There is no possible way that the commonwealth rebounds…the financials are a disaster…these are comments we’ve heard ad nauseam. These comments, though, don’t help investors much and really reduce the situation to a few catchy soundbites.
For our investment team, when analyzing municipal debt, two of the major factors we consider are willingness and ability to pay. Puerto Rico’s governor, Alejandro Garcia Padilla, has definitely demonstrated a willingness to pay, even though he’s only been in office for 13 months. In fact, an investment bank recently commented that if the state of Illinois had made half of the structural changes that Puerto Rico has implemented over the past year, Illinois’ debt rating could be as high as AA.
As to ability to pay, they’re buying themselves some wiggle room. A recent conference call highlighted Puerto Rico’s endeavors in the following areas: budget austerity, tax reform, public corporations reform, and employment. Additionally, there are actually some positives here because the commonwealth’s bonds should see some price support because their debt is now appealing to crossover investors (i.e., hedge funds) and high yield funds. These are non-traditional muni buyers and they have an insatiable appetite for distressed paper. We would expect this additional demand to keep their yields down, all other things being equal. The timing is fortuitous because of anemic supply elsewhere, so our guess is that the deal will get done.
So to give you an idea of how the situation looks from our perspective, we’ll take a look at the relevant data, make educated assumptions, and attempt to extrapolate in a “back-of-the-envelope” manner.
Here’s where the Caribbean utopia of Puerto Rico stands:
2014 (Fiscal Year-End 6/30/14)
Existing cash balance (unrestricted): $1.4 billion
Government Development Bank cash equivalents: $2.8 billion
March approximate issuance: $2.86 billion
Bridge the current operating deficit in the Operating Fund ($245 million)
(Legally not allowed to have a deficit)
Downgrade triggers provisions in specific debt ($940 million)
($100 million-collateral/$840 million put feature)
*Unlikely will the outflow be this large; it’s presently being restructured, but we’ll assume a worst-case scenario.
* The prospective issuance in March would likely be used to eliminate this debt if it is not advantageously renegotiated.
Puerto Rico Government Bank debt maturity ($613 million)
(Already netted from cash, not applicable to running total)
Puerto Rico Government Bank debt maturity ($690 million)
COFINA BAN’s debt maturity ($333 million)
(This is subordinate and not a direct affiliate, but the income disparity has to supplemented by the Government Development Bank, so we’ve included to be conservative)
War Chest Balance: $4.85 billion
2015 Operating Deficit —————–?
The accounting involved in achieving no budget deficit in 2015 allows Puerto Rico to push off principal with refinancing. However, debt service needs to be recognized when their economists sit down with the operational and maintenance budget of $650 million, new debt service of $200 million, and amortization of $50 million. Consequently, Puerto Rico may have created some wiggle room regarding cash flow, though they will likely start fiscal year 2015 with a structural deficit of $900 million. Add-on bills (additional tree plantings, clean energy initiatives, etc.) can be easily subtracted, but are more difficult to find. The challenge for Puerto Rico will be curtailing the costs associated with various public labor unions (where employee consent is necessary). Luck and maneuverability will provide liquidity strength and time to heal. That said, unless they can come up with some recurring cost reductions, the structural deficit will create a monthly cash drain. And that won’t be sustainable in the long term.
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