Post-Hurricane Maria’s devastation, Puerto Rico’s financial struggles have worsened with parts of the commonwealth still without power and many people struggling to meet their basic needs. In his efforts to prioritize the continuation of public essential services over making debt service payments, Puerto Rico’s Gov. Ricardo Rossello has recently proposed his fiscal year 2019 General Fund budget that has $0 allocation toward the island’s central government debt service.
If this proposed budget passes, it will be contrary to Puerto Rico’s debt oversight board’s decision that contractually obligated the central government to pay $2.54 billion in debt service in the fiscal year 2019.
In this article, we will take a closer look at Puerto Rico’s debt restructuring plan, adherence to the oversight board’s fiscal plan and what $0 budget allocation means for Puerto Rico’s bondholders.
Check here for a previous article that explores whether Puerto Rico Electric Power Authority would lose its professional oversight due to debt mismanagement issues.
Current Status of Puerto Rico’s Debt Restructuring Efforts
When Puerto Rico defaulted on its general obligation debt in mid-2016, Gov. Alejandro Garcia made his stance very clear about paying educators, emergency personnel and other essential services providers before meeting the island’s debt service payments. This happened even after knowing that the island’s constitution prohibits meeting any other financial obligations prior to making its general obligation (GO) debt service payments.
Keep our glossary of municipal bond terminologies handy to familiarize yourself with different concepts commonly used by municipal investors.
Post its default on the GO debt, the Federal Financial Oversight Board pushed Puerto Rico into a restructuring process, known as Title III, similar to the restructuring processes that occurred in Detroit, MI, and Stockton, CA, amid their financial struggles. However, what sets this restructuring apart from Detroit or Stockton is its magnitude. Puerto Rico’s financial restructuring process for its $70 billion debt portfolio, and potential restructuring of its $40 billion pension liabilities will be one of the biggest undertakings for any local or state government in the history of the United States.
Throughout the debt restructuring process, the oversight board implemented a fiscal plan that contractually obliged the central government and its related borrowing entities to pay over $2.5 billion in debt service in 2019 fiscal year; later, in March 2017, this plan was revised to increase the debt service obligation to $3.84 billion in FY 2019. It was also determined that all budgets must be approved by the oversight board to not only ensure proper allocation of the budget to the above-mentioned debt services but also ensure the much-needed financial cuts to make ends meet.
Be sure to check our newly launched Municipal Bond Screener to explore muni bond CUSIPs across the U.S. based on custom parameters including the issuing state, insurance status and a range of different bond attributes such as maturity, coupon, price and yield.
Key Concerns Over the Governor’s Proposed Budget
While Gov. Ricardo Rossello’s proposed budget certainly deviates from the oversight board’s fiscal plan for Puerto Rico by not allocating any money toward the GO debt service payment obligation of over $3.0 billion for the fiscal year 2019, it’s also being seen as a political move to keep good with his constituents. Rossello’s proposed budget overlooks the fiscal measures set in place by the oversight board to tame things like pension obligations. In addition to the financial and debt oversight, the oversight board had also created a fiscal budget for the governor to follow; however, in Rossello’s proposed budget, the oversight board’s fiscal budget almost seemed to have been overlooked.
We have listed some of the key points of difference between the two proposed budgets.
- Throughout the restructuring efforts, the oversight board’s fiscal budget projects surplus funds of $1.13 billion, which were not included in Rossello’s fiscal year 2019 proposed budget.
- Gov. Rossello also didn’t include the 10% cut to pension obligations that was proposed in the fiscal budget put forward by the oversight board. Moreover, the proposed budget does not eliminate the Christmas bonuses as suggested by the oversight board. Puerto Rico’s current yearly pension obligations are around $2.22 billion.
- The entire proposed General Fund budget is $8.79 billion, falling short by 8% from the approved budget for the current year. Besides, the proposed budget for operational expenditures is around 7% less than the current fiscal year budget.
Click here to read more about the situation of Puerto Rico’s Cofina debt.
The Oversight Board vs. Gov. Rossello
Since Rossello’s proposed budget doesn’t follow or incorporate the fiscal plan and deviates from the restructuring efforts set forward by the oversight board, the board is likely to reject it.
There might also be a push to impose the board’s budget to follow the fiscal plan. In a letter sent to Gov. Rossello, the oversight board demanded a proposed budget that was consistent with the board’s fiscal plan by May 4. The deadline was later extended and the board set up May 25 as the deadline to take a final decision. In a meeting held this Thursday, the Financial Oversight and Management Board and Gov. Rossello reached an understanding to follow the changes highlighted in the fiscal plan. These changes include pension reform to freeze pension benefit accruals at the beginning of FY 2020 (July 1, 2019) in accordance with the plan of adjustment, enrolling employees in the defined benefit plans, labor reforms and highlighting new investment priorities.
Implications for Puerto Rico GO Debt Investors
In a municipal bankruptcy or restructuring process of a local government’s finances, it becomes imperative to establish a fiscal plan to get out of that situation. Yet, it is even more crucial to follow that plan and ensure that all the necessary steps are being taken to obtain fiscal stability. In the case of Puerto Rico’s current environment, the oversight board set forward an established fiscal plan. As discussed previously, it seems that both the board and the governor have reached common ground in terms of the proposed fiscal plan.
As the original proposed budget (FY 2019) fell completely out of line with the fiscal budget set out by the oversight board, it shows that the commonwealth’s leader is demonstrating a lack of desire to pay back the debt or make any debt service payments in the near future. This would make existing and potential muni investors think twice before they decide to invest in U.S. muni debt issued by an entity with shaky financials.
In recent discussions, Gov. Rossello showed his acceptance of the oversight board’s requested changes according to the plan of adjustment. If the governor’s future fiscal proposals fail to meet the fiscal plan and its measures, the oversight board can impose its own budget, which might bring a sigh of relief from bondholders as the oversight board would like to ensure the predetermined budget allocation toward debt service. The oversight board and politician’s inability to see eye to eye on fiscal planning and financial preparedness can present a high degree of uncertainty in what might happen with Puerto Rico’s finances and how bondholders will be affected and repaid going forward. This will likely have a negative impact on Puerto Rico bond prices and potentially increase the volatility.
Check out the different ways to invest in muni bonds to stay up to date with the current investment strategies.
The Bottom Line
The fiscal crisis in Puerto Rico, combined with recent natural disasters, has created even bigger challenges for the Commonwealth and its people. For the everyday municipal debt investor, Puerto Rico serves as a great example that highlights the intricacies and political influence on municipal debt markets and challenges the beliefs held by many investors about their investment holdings.
In the case of Puerto Rico, the proposed budget is a good indicator of the fierce disagreements between the ruling political party and the fiscal oversight board. Even though the recent discussions seem to bridge the gap between the two parties, there is still a chance that current bondholders might suffer from $0 allocation toward their debt service.
By becoming a premium member, you can get immediate access to all the latest Moody’s credit reports for municipal bonds across the U.S. and enhance your analysis for a specific security.
Disclaimer: The opinions and statements expressed in this article are for informational purposes only and are not intended to provide investment advice or guidance in any way and do not represent a solicitation to buy, sell or hold any of the securities mentioned. Opinions and statements expressed reflect only the view or judgment of the author(s) at the time of publication and are subject to change without notice. Information has been derived from sources deemed to be reliable, the reliability of which is not guaranteed. Readers are encouraged to obtain official statements and other disclosure documents on their own and/or to consult with their own investment professionals and advisors prior to making any investment decisions.