STUMP » Articles » Digging into the Near Past: Puerto Rico's Finances » 2 July 2015, 09:28

As with my post on the Greek Crisis, the problem with Puerto Rico has been building up for a long time.

As with Greece, pensions play a major role, but migration of the population plays a huge role in the past five years.

I will be digging through my public finance and public pensions threads from the Actuarial Outpost to source these. When the news links no longer work, I will like to the AO post.

A DEFAULT A LONG TIME IN THE MAKING

January 2011, from the NYT:

Moody’s Investors Service has begun to recalculate the states’ debt burdens in a way that includes unfunded pensions, something states and others have ardently resisted until now.

States do not now show their pension obligations — funded or not — on their audited financial statements. The board that issues accounting rules does not require them to. And while it has been working on possible changes to the pension accounting rules, investors have grown increasingly nervous about municipal bonds.

Moody’s new approach may now turn the tide in favor of more disclosure. The ratings agency said that in the future, it will add states’ unfunded pension obligations together with the value of their bonds, and consider the totals when rating their credit. The new approach will be more comparable to how the agency rates corporate debt and sovereign debt. Moody’s did not indicate whether states’ credit ratings may rise or fall.

Under its new method, Moody’s found that the states with the biggest total indebtedness included Connecticut, Hawaii, Illinois, Kentucky, Massachusetts, Mississippi, New Jersey and Rhode Island. Puerto Rico also ranked high on the scale because its pension fund for public workers is so depleted that it has virtually become a pay-as-you-go plan, meaning each year’s payments to retirees are essentially coming out of the budget each year.

By the way, there have been some changes to governmental accounting, but I don’t want to get into that.

Unfortunately, the Puerto Rican pension info isn’t in the Public Plans Database, or I’d put some extracts here. I will have to see if any info is available later.

April 2013, from Investment News:

Puerto Rico’s muni-bond risk bears watching, BlackRock managers say
Territory’s debt is widely owned; ‘fattest tail risk’ in the market

If you are looking for signs of cracks in the municipal-bond market, keep your eyes on Puerto Rico, not California. If the market were to begin anticipating a default of the U.S. territory’s muni-bond funds, it could start a Meredith Whitney-like run on the tax-free bonds, top managers in BlackRock Inc.‘s muni bond group said at a press conference in New York Thursday, referring to the founder of Meredith Whitney Advisory Group LLC. “Puerto Rico is the fattest tail risk in the muni market,” said BlackRock muni strategist Sean Carney.

October 2013 from the NY Times:

Worsening Debt Crisis Threatens Puerto Rico
By MARY WILLIAMS WALSH OCTOBER 7, 2013 8:48 PM

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.

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.

We will see about that ability to file for bankruptcy.

That is an interesting twist that will be coming soon, I think. Because Puerto Rico (and states) can definitely default on their debt. No laws can wish money into being (money with actual market value, that is.)

Bankruptcy is protection for creditors as well as debtors. Not having a bankruptcy process doesn’t prevent inevitable defaults. What it does is provide an orderly way to tell claims and get things started up again.

December 2013, from the Washington Post:

Puerto Rico, with at least $70 billion in debt, confronts a rising economic misery

….
The economy here has been in recession for nearly eight years, crimping tax revenue and pushing the jobless rate to nearly 15 percent. Meanwhile, the government is burdened by staggering debt, spawning comparisons to bankrupt Detroit and forcing lawmakers to severely slash pensions, cut government jobs and raise taxes in a furious effort to avert default.

The implications are serious for Americans outside Puerto Rico both because a taxpayer bailout would be expensive and a default would be far more disruptive than Detroit’s record bankruptcy filing in July. Officials in San Juan and Washington are adamant that a federal bailout is not on the table, but the situation is being closely monitored by the White House, which recently named an advisory team to help Puerto Rican officials navigate the crisis.

The island’s problems have ignited an exodus not seen here since the 1950s, when 500,000 people left for jobs on the mainland. Now Puerto Ricans, who are U.S. citizens, are again leaving in droves.

They are choosing the uncertainty of the job market in Orlando or New York City or Philadelphia over what they view as the certainty that their dreams would be crushed by the U.S. territory’s grinding economic problems.

…..
Puerto Rico lost 54,000 residents — 1.5 percent of its population — between 2010 and 2012 alone. Since recession struck in 2006, the population has shrunk by more than 138,000 to 3.7 million, with the vast majority of the outflow headed to the mainland.

The brutal combination of a long recession, a shrinking population and overwhelming debt has left Puerto Rico’s political leaders struggling to manage a conundrum: How do they tame at least $70 billion in debt while marshaling the resources to grow a shrinking economy and battle corrosive social problems, including a homicide rate that is nearly six times the U.S. average?

…..
Not long after Padilla took office in January, Wall Street debt rating agencies downgraded the island’s bonds to just one rung above junk status. Like states, the commonwealth of Puerto Rico cannot file for bankruptcy. Also, Puerto Rico’s constitution offers bondholders strong guarantees that they would be paid before pensioners and public workers if the government went broke.

Yeaaaah, let’s see about that.

QUICK JUMP FORWARD

We see in this story from February, that the constitutional guarantees threw a wrench into restructuring attempts:

(Reuters) – Hopes of an orderly resolution to Puerto Rico’s debt crisis suffered a heavy blow after a court voided the island’s restructuring law, raising fears it may be heading for a longer, messier debt overhaul.

Late on Friday a U.S. federal judge ruled that the U.S. commonwealth’s so-called Recovery Act, which made some of Puerto Rico’s agencies eligible for court-supervised debt restructuring, violated the U.S. constitution by allowing a state government to modify municipal debt.

“This decision will ultimately result in a resolution being dragged out over a longer period of time, having the administrative costs incurred eat into the ultimate recovery for the bondholders,” said Tom Metzold, a senior portfolio advisor at Eaton Vance, which holds various insured Puerto Rico bonds.

Puerto Rico is expected to appeal the ruling, kicking off lengthy litigation with a hard to predict outcome and possibly delaying for months the matter’s final resolution.

Bondholders are, however, likely to interpret Friday’s ruling as a sign that the Puerto Rico authorities are on shaky legal ground. That could lift bonds of public corporations such as the Puerto Rico Electric Power Authority (PREPA) covered by the voided law, by strengthening bondholders’ negotiating position, investors said.

In contrast, holders of General Obligation (GO) bonds issued by the island could take a hit. The Recovery Act meant to isolate the government from potential liabilities incurred by agencies such as PREPA and that protection may now be in doubt.

…..
U.S. law forbids Puerto Rico’s government and its entities from restructuring debt under Chapter 9 of the U.S. bankruptcy code, which was used for Detroit last year, so the Puerto Rico government passed its own restructuring law in June based loosely on U.S. bankruptcy rules.

Again, being able to have a bankruptcy process is important, because it allows things to work out before everything falls apart.

Anyway, this was the U.S. constitution and law, not the Puerto Rican constitution.

BACK TO OLDER STORIES

January 2014, from Forbes contributor Larry McDonald:

States with the Most Public Debt vs their Size of Population

California $99B vs 38 million people

New York $62B vs 19 million people

Puerto Rico $52B vs 3.6 million people

Credit Contagion; Toxic Side Effects

A default in Puerto Rico would re-price the entire $3.7 trillion US Municipal bond market, costing states and counties across America billions in additional interest rate charges. Once investor confidence is lost, it’s like losing personal trust, and becomes almost impossible to get back. So far Puerto Rico’s $52 billion pile of bonds were off 20 points in 2013, already costing US investors nearly $10 billion.

An unsustainable, systemic risk debt bomb has been formed. If there was a picture of moral hazard in the dictionary, Puerto Rico’s image would be right there next to Fannie and Freddie, the US government sponsored entities that already received a $180 billion bailout from taxpayers.

Let me do some ratios from the numbers he gives:

California: $2.6 K per capita

New York: $3.3 K per capita (phew!)

Puerto Rico: $14K per capita (uhhhh)

And he’s not even including pension debt, as far as I can tell. Just the outright bonds.

January 2014 from CNBC, though the original link doesn’t work. A link to the Actuarial Outpost post:

Creditors to Puerto Rico are meeting in New York on Thursday with lawyers and debt restructuring specialists as the territory appears increasingly likely to default on its $70 billion in public sector debt and an additional $40 billion of unfunded pension liabilities, these specialists say.

A possible suspension on payment of the debt comes despite the progress Puerto Rico’s Gov. Alejandro Garcia Padilla has made in raising taxes and reducing the territory’s deficit.

Any such decision partly reflects legal complications arising under Puerto Rico’s ambivalent status, which today makes a Chapter 9 filing for bankruptcy protection for local governments, such as the Detroit municipal filing last July, impossible. It also reflects the maths of a debt service burden that requires paying between $3.4 billion and $3.8 billion each year for the next four years. As doubts grow about the ability of the commonwealth to service that debt, the cost of doing so will inevitably rise.

“The numbers are untenable,” said one restructuring adviser. “To issue new debt the yield would have to rise and where they can’t raise new money they will have to stop paying.”

If Puerto Rico is forced to take that step, the effects will ripple through the entire $4tn municipal bond market. Because the debt is generally triple tax free, in a world of zero interest rates demand is high and it is distributed widely, including in funds that imply they have no exposure to Puerto Rico.

But yields have gone up nevertheless (and prices down), suggesting the markets are increasingly nervous about prospects for repayment. (Estimates on how much of that debt is insured range from 25 percent to 50 percent of total issuance.) “Everyone thinks they can get out in time,” the restructuring adviser added.

Puerto Rico cannot really raise taxes much more, since the debt per capita is more than $14,000, while income per capita is almost $17,000, a ratio at 83 percent—that makes California, Illinois or New York—each at 6 percent—models of prudence. Meanwhile, at 14 percent, the unemployment rate is twice the national average.

At least these per capita measures are similar to what I saw.

February 2014 from CNBC:

S&P cuts Puerto Rico’s general obligation debt ratings to junk

Standard & Poor’s on Tuesday cut its credit rating on Puerto Rico, dropping the cash-strapped U.S. territory’s debt to junk-bond status on concern about its ability to access capital markets.

S&P, which had placed Puerto Rico’s rating on notice for a downgrade last month, said it now rates the Caribbean commonwealth at “BB ,’‘ one level below investment grade. Previously it had rated it “BBB-.”
With some $70 billion of tax-free debt, Puerto Rico has a long soured economy and has for months been under threat of a ratings downgrade to junk-bond territory by all three U.S. credit ratings agencies.

March 2014 from the WSJ:

Puerto Rico Sets Coupon, Yield Range for $3 Billion Bond Deal
Puerto Rico Bonds Seen Yielding 8.625%-8.875% With 8% Coupon

Puerto Rico is expected to sell at least $3 billion in debt Tuesday in what would be the U.S. commonwealth’s largest bond sale, an important step in the island’s efforts to bolster its finances.

Bankers led by Barclays PLC, Morgan Stanley MS -0.25% and RBC Capital Markets closed the order period Monday for investors, who were expected to be largely institutional managers given the minimum order size of $100,000. The bond sale was announced last week at $3 billion with a final maturity of 2035.

Orders were strong, said people familiar with the deal, which means the size of the sale could increase.

Investors buying the debt are expected to receive bonds yielding between 8.625% and 8.875%, according to investors. Those yields are on the lower end of expectations that investors have bandied about since the sale began to come together last month but are higher than the island’s exisiting benchmark issue that matures in 2041, which traded around 7.5% on Monday.

The sale is a crucial piece of Puerto Rico’s plans to manage its $70 billion in debt outstanding amid high unemployment and pressure from investors for fiscal overhaul. Speculation that the island would be forced to restructure its debt last year sent its bond prices falling, handing double-digit losses to holders, including many municipal-bond mutual funds. Puerto Rico officials have said they expect to pay all of the island’s obligations off in full.

How well has that worked out? Mmmhmmm.

June 2014 from ThinkAdvisor:

Muni Bond Experts Sound Short-Term Warnings on Puerto Rico, Long-Term on Local Munis
Morningstar panel disagree on opportunities in Puerto Rico, but agree that the muni bond world is changing, not necessarily for the better

At the Morningstar Investment Conference, Rob Amadeo of Western Asset Management, Joseph Deane of PIMCO and John Miller of Nuveen spoke on munis for Puerto Rico, Detroit and Chicago, but also looked at the bigger picture for municipal debt in light of moves to reduce the federal deficit, which might well have negative trickle-down effects on local governments.

As for Puerto Rico, Deane said that at PIMCO, where he heads municipal bond portfolio management, “we don’t own anything on the island.” Calling the Puerto Rican debt “a very, very difficult situation,” he pointed out that this “small island in the Caribbean” is the third largest debt issuer in the United States — after California and New York — which he said was “unsustainable.” He further warned of a human capital problem on Puerto Rico: “there’s been a big brain drain over the last few years” from the island as its economy has stumbled while its debt burden has risen.

Seriously, people had to have seen this coming.

DECREASING POPULATION

I just took a look at some Census numbers, with estimates from 2010 – 2014, based on July 1 estimated population.

Here is a google spreadsheet you can look at, to check my numbers.

Here are some facts about Puerto Rico:

• From 2010 to 2014, Puerto Rico slipped from 29th to 30th in population of the states, itself, and D.C.
• Its population decreased a total of 4.7%, the worst growth rate of the 52 states/regions.
• Only one other place – West Virginia – had negative growth, and WV’s decrease was only 0.2%

I found some interesting things re: growth among the states, but until I looked, I didn’t know how bad it was for Puerto Rico.

DID WE MENTION PENSIONS?

I want to remind: the debt load being mentioned above is all just to bondholders. It doesn’t include unfunded pension obligations (or any other retiree obligations).

If you look up again at that first story from Moody’s in 2011, they estimated $23K per capita in debt if you included unfunded pensions in there — an additional $10K per capita, almost doubling the per capita debt load.

From February 2013 on Fox News Latino:

Puerto Rico’s Pension Problem Could Send Economy Over the Edge

SAN JUAN, PUERTO RICO – Puerto Rico’s public pension system is in debt $37.3 billion and could send the territory over the fiscal edge in what economists and financial analysts say is a ticking time bomb.

Puerto Rico’s problems stem from decades of neglect as politicians facing budget deficits were unwilling to set aside money for the growing ranks of retired police, firefighters, teachers and office workers. Now many analysts and even some government officials concede it is the most critical issue facing the administration of newly elected Gov. Alejandro Garcia Padilla.

…..
Nearly all of the problem centers on two pension systems — one for teachers and one for other government workers — that stopped accepting new beneficiaries in January 2000. They serve more than 273,000 active and retired government workers.

Those initially allowed workers to retire at age 55 with 25 years of service or at age 58 with 10 years of service. In 1990, legislators made significant changes, reducing benefits and increasing the retirement age from 55 to 65 years for newly hired workers.

As liabilities mounted, legislators scrapped that system 13 years ago, creating a new system that is more like a 401(k)-type plan in which workers must make their own contributions.

The newer defined-contribution plan is considered financially stable. But the older plan will have used up its assets “within several years,” Karen Krop, a senior director of public finance at Fitch Ratings.

More from Bloomberg in February 2013:

Puerto Rico Set to Boost Worst-Funded Pension Sans Debt

Feb. 22 (Bloomberg) — Puerto Rican lawmakers must beef up the government’s underfunded pension, which has less than 7 percent of needed assets, and may get their chance by next week, according to a legislative leader.

Okay guys. I may bitch and moan about the 80 percent funding myth, but 7% is pretty much nonexistent funding.

April 2013 saw the passage of pension reform:

REFILE-Puerto Rico to approve public pension overhaul this week

• State employee contributions to be raised to 10 pct

• Officials proposing to freeze defined contributions

SAN JUAN, April 3 (Reuters) – Lawmakers in Puerto Rico are expected to approve legislation on Thursday to reform a woefully unfunded public pension system that risks to run out of money in five years.

…..
Puerto Rico has already ended defined benefit pensions for employees hired after 2000. Officials are proposing that defined benefits currently enjoyed by employees be frozen as of June 30, and those workers be moved into a defined contribution plan.

Under the proposed reform, state employee contributions would be raised to 10 percent from 8.275 percent.

Christmas and summer bonuses for pensioners would be reduced or eliminated for workers and the retirement ages for public workers would be increased.

The proposed pension changes will help keep the system, which is expected to run out of money by 2018, afloat until about 2040, officials say, when the system self-corrects because of the end of the defined benefits for employees hired after 2000.

The bill did pass and get signed.

Okay, I could detail the protests that occurred throughout 2014, but guess what: the reforms were declared unconstitutional in April 2014:

Puerto Rico’s Supreme Court ruled that changes to the teachers’ pension system are unconstitutional, according to Caribbean Business.

Governor Alejandro Garcia Padilla last year enacted legislation that boosted the retirement age and increased the amount that teachers contribute to their pensions. Without those changes, Puerto Rico’s yearly payment to the system would be short $500 million annually, according to the Government Development Bank, which handles the commonwealth’s financial transactions.

The ruling, which couldn’t immediately be confirmed in court records, threatens the governor’s pledge to release a spending plan for the fiscal year beginning July 1 that doesn’t include borrowing. The practice has been used in every budget since at least 2000. The three largest rating companies lowered Puerto Rico to speculative grade in February and gave it a negative outlook.

Puerto Rico sold $3.5 billion of tax-exempt general-obligation debt March 11 at 93 cents on the dollar to balance budgets and give it enough cash through July 2015. The bonds traded today at 86 cents, the lowest ever and down from as high as 99 cents on March 12, data compiled by Bloomberg show.

Lawmakers also passed the changes to help strengthen the pension fund. The Teachers Retirement System, which includes 80,000 current and retired educators, had 17 percent of needed assets to pay current and future retirees and an unfunded liability of $10.3 billion as of June 30, 2012, according to the GDB.

Today’s decision is a reversal from last year, when the island’s highest court upheld similar changes to Puerto Rico’s Employees Retirement System.

NOW WHAT?

The latest chatter seems to be that yes, maybe having a bankruptcy process would be a good idea. The idea is coming from the Democrat side, but that doesn’t mean it’s wrong. Normally, I would be skeptical of something Chuck Rangel supports, but I happen to think they’re right about this.

Without a clear legal process, there’s not much Puerto Rico can do.

The problem is that if you can do it for Puerto Rico, it seems to be pretty easy to extend it to states.

HMMMMM

Yes, there are sovereignty problems if states can go through federal bankruptcy courts, but federal courts are already involved when states are party to suits. I don’t think this is necessarily different.

Anyway, the question is what states do when they default on their obligations.

At least this isn’t a medieval monarchy where the go-to would be to eject the creditors from the country (as King Edward I did with the Jews in England) or outright killing people and taking their assets (cf King Henry VIII, Ferdinand and Isabella of Spain, etc).

Wait, maybe I shouldn’t be giving them any ideas.

Compilation of Puerto Rico posts

The State of the States: a Compilation